Last week, this column sought to analyze what appears to be a strong case for oil prices remaining above $30/bbl for the rest of the year.
Can an equally strong case be made for the prospect of an oil price collapse this year? It certainly remains a reasonable possibility.
Oil markets reacted to the brief Mar. 12 meeting of the Organization of Petroleum Exporting Countries in a somewhat surprising fashion. OPEC refusing to endorse officially a pledge to produce all out in case of war—instead just giving vague assurances about meeting supply needs—ordinarily would be perceived as a bullish factor for prices, judging from past market behavior. Instead, oil prices fell. In the past, traders tended to overreact to whatever OPEC did or didn't do. Now it seems they are taking OPEC for granted and just reacting to the war drums and the weather. With both those factors easing at the time of the OPEC meeting, perhaps the brief price decline shouldn't have been a surprise.
OPEC assumptions
Still, it would not be wise to take OPEC for granted. The group, especially Saudi Arabia, has gone to some lengths not only to assure consuming nations there would be no shortage of oil, but to follow that up with action. The Saudis in particular have ramped up production. But the kingdom has asserted it won't produce beyond 9.2 million b/d; converting the last 1.3 million b/d of its 10.5 million b/d of capacity to live production would entail major investments and only contribute to what the Saudis fear could be an oil glut in the making.
This is a bit at odds with the key finding of the latest oil market report from the International Energy Agency. IEA contends that OPEC's "effective" capacity fell below 1.7 million b/d and could drop below 1 million b/d in March. This, the agency notes, is less than the potential loss of supply in the event of war in Iraq.
What some analysts have pointed out in response to the IEA claim is that it overlooks two things:
That available productive capacity has shrunk because production has increased so sharply this year.
That the large volumes of oil the Saudis and others have already produced this year are in excess of actual physical consumption. In other words, much of the increased output has gone toward buildup of floating oil stocks near major consuming centers, particularly in the Caribbean.
A big part of the reason that oil prices have remained high is that much of this added production in January and February has yet to arrive in consuming nations.
This is why the Saudi oil minister recently has been whistlestopping to meet with the likes of the US energy secretary, giving assurances of adequate supply, followed shortly by the US reiteration of its stance that the Strategic Petroleum Reserve would not be drawn down except in the event of a major supply outage. Certainly, that addresses Saudi concerns about a premature flood of strategic stocks, even if OPEC did decide to sit on its hands for now. That also suggests a Saudi comfort level with OPEC's ability to meet an Iraqi outage.
Glut on the horizon?
But IEA doesn't appear to share that comfort zone. That's understandable, given the increasing likelihood not only of war but of Iraq destroying its own oil production capability.
If the Saudis are successful in lobbying IEA, then the onset of war would be accompanied by a limited release of strategic stocks—probably only the US SPR, and probably 1 million b/d.
But a bigger release, involving a coordinated IEA effort, could add another 1 million b/d to supply at a time when OPEC is producing all out, when Venezuelan output has rebounded from December levels by 1 million b/d or more, when demand slackens (as it always does) in the second quarter, and when that extra 1.5 million b/d of other OPEC oil arrives at consuming nations' shores.
If this scenario is compounded by the Iraqi and Venezuelan volumes remaining in the equation, we then have the makings of a supply glut. Under such a scenario, some analysts see oil prices plunging to the lower end of the OPEC basket price band target of $22-28/bbl by summer.
So it has become imperative for the Saudis to convince IEA of OPEC's ability to meet any shortfall. If they fail, look for another Saudi-led scramble to cut OPEC production in the second half.
(Online Mar. 14, 2003; author's e-mail: [email protected])
