Energy markets remain tight

Sam Fletcher
Senior Writer

HOUSTON, Jan. 7 -- The US Energy Information Administration expects growth in world demand for oil to slow this year in reaction to high prices, down 23% to an increase of 2 million b/d. But that still would outstrip the expected increase of crude production among nations outside the Organization of Petroleum Exporting Countries and would keep world markets tight, EIA said.

Adnan Shihab-Eldin, OPEC's acting secretary general, said crude prices "appear to be moving toward [market] fundamentals" in a retreat from nominal record high levels late last year. OPEC is projecting oil demand growth of 1.6 million b/d in 2005, with Asia accounting for much of that increase. That would require OPEC to supply 28 million b/d of crude in 2005, said Shihab-Eldin.

OPEC ministers voted Dec. 10 to reduce overproduction by 1 million b/d effective Jan. 1, while retaining their production quota of 27 million b/d for the 10 members except Iraq (OGJ Online, Dec. 10, 2004).

OPEC's decision appears to have imposed more stability in the world oil market, said Paul Horsnell of Barclays Capital Inc., London. "First, prices have not only stabilized, but they have done so in the proximity of $35[/bbl] for the OPEC basket, a level which has looked increasingly like the new effective target for the midpoint of trading ranges. Second, the implementation of the cuts from above-quota production seems to have gone very smoothly. Saudi [Energy] Minister Ali [Al-]Naimi has confirmed that Saudi Arabia has moved back to 9 million b/d, and other members also seem to have moved to implement the agreement swiftly. The knock-on impacts of the cuts already seem apparent in the extremely sharp drop in tanker rates out of the Middle East and also in the ability of producers to move to narrow the adjustment factors used in the price formula of heavier crudes," he said.

'A clear signal'
Moreover, the scheduled meeting of OPEC ministers Jan. 30 provides "a clear signal that if the value of the OPEC basket starts to move below $35 or if ministers feel that global supply-demand second-quarter balances are not likely to be supportive enough, then a cut in quotas is more than likely. In all, that has constituted a fairly strong incentive for traders not to have wanted to stray too far away from $35 for the value of the OPEC basket," said Horsnell.

"OPEC will introduce a new price band and likely [will] defend it strongly," agreed analysts at Global Insight Inc., London. "However, some of the quota squabbling may reemerge if global growth slows down." OPEC's current target price band, established in 2000, is $22-28/bbl.

Global Insight analysts expect "a higher baseline oil price" this year that will pressure international oil companies to "increase capital expenditure outside existing holdings." They said, "A relative lack of 'safe' investment options will encourage the shift towards more high-risk locations, forcing difficult choices between security and low growth vs. risk-taking and more substantive returns."

They see the Middle East offering both risks and rewards. "While it may still be too soon for any substantive Iraq opportunities to emerge, some of the groundwork should be laid. Libya will see the most interest," they said.

'Safe and effective'
Horsnell commended OPEC for placing the secretary general position in Shihab-Eldin's "safe and effective" hands. "There have perhaps in the past been just a tad too many red herrings and other diversions introduced into oil policy debates, often more by accident than design. However, under Dr. Shihab-Eldin, we would expect the OPEC secretariat to become a relatively herring-free zone," he said.

At any rate, Horsnell said, "The oil market appears to be far more under control than a month ago, although the resolution of the current fog in global balances may lead to a more decisive break." He said, "Over the coming weeks, we could yet find that the global situation is slacker than first thought and hence that OPEC has some more work to do. Alternatively, and this remains our base case, we could find that demand has continued to be underestimated, and non-OPEC supply overestimated, and that the market will prove tighter than consensus."

Meanwhile, said Horsnell, "Patterns in the Northern Hemisphere winter remain the important factor, particularly given the extremely distillate-driven nature of current oil market conditions. For the US market, there does seem to be a perception that the winter has been unseasonably mild and far warmer than last year. The reality in the data is different, primarily due to the extent that the gaps were closed by very cold conditions in the last 2 weeks of the year."

(Author's e-mail: sfletcher@ogjonline.com)

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