Little chance remains that oil markets will cool off this year

What will it take to get OPEC to produce more oil? If the sight of Pres. Bill Clinton coming to US allies in OPEC, hat in hand, begging for more oil is not enough to move OPEC, then what is?

There is now virtual unanimity that the market needs more crude oil—everywhere but within OPEC, that is. Even the Saudis, who retrenched from their earlier bold statement to push more crude into the market, are having second thoughts about whether that extra crude is even needed.

The Saudis did, in fact, produce more oil last month but that was, arguably, not for export, says the Centre for Global Energy Studies. The London think tank notes that Saudi domestic crude oil use for desalination and power generation rises in the summer.

CGES also points out that Saudi Arabia "thinks that more crude is actually not wanted, given its difficulty in selling extra sour crude cargoes."

But that difficulty may, in fact, simply result from the fact that the Saudi sour crude is overpriced.

More oil needed

It almost goes without saying, CGES contends, that the oil industry needs to build both crude and product stocks.

While the problems with tight gasoline supplies seem to have been resolved, the problems with low stocks of crude oil continue, and the concerns over low stocks of distillates will only grow.

CGES estimates that distillate stocks in the US at the end of July provided only 30 days' worth of cover, which is 6 days lower than in the same period in 1999. Building those stocks in time will be extremely problematic, as crude stock cover in the US and Europe are also very low.

Time is running out, and there is little financial inducement for OPEC to push a great deal more crude into the market, the analyst contends: "To put extra barrels into stock in the present backwardated market is not sensible; it is better to sell prompt oil and buy futures.

"Building inventory requires a rising forward curve and, for that to happen, the market needs more wet barrels over a period of time."

OPEC's gamble

Meanwhile, OPEC continues to make hay while the sun shines—but dusk is beginning to gather quickly on the horizon.

While CGES estimates that OPEC will enjoy an infusion of another $80 billion in extra export revenues this year, there are already signs that high oil prices are eroding demand.

A report to the UN last week concluded that energy demand in the developing world has fallen by 2.3% in the preceding year, "seriously" hampering economic performance and social development in these countries. While OECD demand sustained its 10-year track record of year-to-year gains in energy use—and while OECD accounts for 60% of world energy use—much of the anticipated high-percentage growth in oil and gas use in the coming decade was expected to emanate from the developing nations.

CGES notes that consumer inflation has risen by almost a percentage point in the advanced economices, moving up in lockstep with interest rates.

"Unsurprisingly, economic growth in these countries is expected to drop to 2.5% per annum in 2001 from 3.5% this year," it said. "One percent less growth implies 0.5 million b/d less oil demand in the OECD, apart from the direct drop in demand due to higher prices."

OPEC could readily supply the market with the oil it needs—the group is capable of producing another 500,000 b/d without any member exceeding its capacity, save for Nigeria and possibly Indonesia, CGES notes. Saudi Arabia alone could take up the slack, but, despite its earlier broadside and any entreaties from Clinton, it isn't likely. In short, OPEC simply would rather risk what its members see as a temporary, gradual easing of demand that can be rectified next year than risk a price collapse now.

(A brief digression: Were the Saudis, in fact, bluffing earlier? Was it a shot across the bow of its OPEC compatriots, setting a stage for a September accord that could endorse incremental volumes above the agreed quota levels—"leakage," as some put it—and thus cool off markets again? Would Riyadh want to be seen as being too chummy with Clinton-Gore during this hotly contested US presidential election, especially in light of the near-certainty that Gore will "back-door" the Kyoto Protocol into the fabric of American society—with all the carnage on oil use that will entail? Conversely, would the Saudi royals be willing to turn their backs on the son of the man who led the free world into Kuwait to defuse the threat of Saddam Hussein, with the image of those American soldiers in a Saudi barracks slain by an Iraqi Scud missile still fresh in their minds? The heating season does not really get under way in the US until after the elections. So any "real" Saudi relief may not come until then. It also pushes Saudi market intervention past the very possible outbreak of violence, perhaps a new intifadah as Palestinians respond to Israeli measures coping with Yasser Arafat's unilateral declaration of Palestinian statehood by a date certain in September, regardless of what happens with peace negotiations in the interim. The Saudis certainly will not want to flaunt a cooperative spirit with the US that, coincidentally, deprives the kingdom of billions in petrodollars, at a time when fundamentalist elements in the country grow restive over the Palestinian statehood issue. It all adds up to a most delicate minuet of diplomacy, indeed.)

The bottom line is that, even if the Saudis and the rest of OPEC jump to the market's rescue, for whatever reason, it is probably too late to do anything to prevent sharp spikes in heating oil prices this winter. Downstream capacity constraints will prevent stocks of heating oil getting rebuilt to acceptable levels, regardless of how much crude reaches the market, in the time window available,

Forecasters are calling for a return, finally, to normal winter weather. And the history of post-El Niño/La Niña weather patterns suggests that this will come to pass this winter.

So while the weather gets progressively colder this winter, oil markets almost certainly will stay hot—maybe even sizzling.

OGJ Hotline Market Pulse
Latest Prices as of August 25, 2000

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