This year will prove the toughest test yet of the Organization of Petroleum Exporting Countries' ability to manage the oil supply-demand balance.
During the past 3-4 years, OPEC has repeatedly confounded many analysts' skepticism over its ability to calibrate supply to meet demand. Now market-watchers have come to expect the group to accommodate the vagaries of demand shifts, even in today's uncertain economic climate, in defense of its target price band of $22-28/bbl for the OPEC basket of crudes (or, more accurately, Saudi Arabia's pursuit of $25/bbl for that basket).
OPEC's Jan. 12 decision to boost quotas did little to quell surging oil prices. Since then, the next-month crude contract on the New York Mercantile Exchange has remained stubbornly above $30/bbl, even approaching $35/bbl at one point. It didn't help that the quota hike included Venezuela's, which is ridiculously moot. Or that the new quota is actually less than what OPEC is producing (although that won't stop some OPEC members from producing even more than their new quotas).
But, more importantly, traders recognize the tightness of physical fundamentals underlying the market. US oil stocks are at their lowest level in 20 years. Even with a weak economic outlook, global oil demand is up on the year, fueled in part by colder weather this winter and Japan's nuclear plant shutdowns. There is no significant spare productive capacity within non-OPEC countries to speak of. And looming over all of this are critical numbers: OPEC's spare capacity of less than 4 million b/d vs. combined Venezuelan and Iraqi production of 5.4 million b/d. Here is another key number, according to the London think tank Centre for Global Energy Studies: 40.
"For the US, the loss of 1.4 million b/d of oil imports from Venezuela in December should have been a clear trigger for a release of oil from the Strategic Petroleum ReserveU," CGES said in its latest monthly market report. "With the nearest alternative source of substantial supplies 40 days away in the Middle East, some 40 million bbl of oil should have been released from the SPR in December to tide refiners over until this replacement oil arrived, calming market fears and prices in the meantime." Whether one agrees with that step being necessary, there certainly has been a jump in the risk premium underlying what A.G. Edwards analysts call the "fair value" of oil ($25/bbl for spot West Texas Intermediate) to $7-8/bbl. Unless something truly dramatic happens to the leadership of either Iraq or Venezuela in the interim, this situation is a pretty sure bet for NYMEX crude remaining above $30/bbl until some of the additional Middle East crude reaches the US by late February.
Price spike scenarios
There have been some pretty wild projections of oil prices under the various outage scenarios that have been concocted. At least one reputable market watcher suggested $100/bbl isn't out of the question, but it would be difficult to envision the kind of apocalyptic scenario in the Persian Gulf that would see prices reaching such stratospheric heights.
Still, tapping that extra productive capacity and then shipping those incremental barrels could take a couple of months. So the simultaneous loss of Iraqi and Venezuelan supplies would almost certainly precipitate a drawdown of strategic stocks worldwide, which, along with price-spike-related conservation, should cap NYMEX oil prices below $40/bbl.
Sudden slump?
But there are signs the Venezuelan strike is weakening. And the betting here is that much of the risk premium related to Iraq would disappear within a matter of a few weeks—perhaps even days, as with Desert Storm in 1991.
Meanwhile, there could be millions of barrels of extra crude from OPEC and strategic stocks flowing into the market just when the risk premium fades during the seasonally slack second quarter.
"Even if other OPEC members were to cut production immediately," said CGES of such a scenario, "there would be 40 days' worth of oil on the water, which would arrive off the coast of Louisiana just as Venezuelan supplies are rising."
CGES thinks that if war is averted in Iraq and Venezuelan exports begin to return to normal levels, other OPEC members would have to react swiftly to cut production again: "With total OPEC production surging to 27 million b/d in second quarter 2003 and being reduced by 1 million b/d each quarter thereafter, oil prices would fall to below $20/bbl by the end of the year."
The Market Hotline scenario? Count on Saudi Arabia and a $25/bbl OPEC basket.
(Online Jan. 24, 2003; author's e-mail: [email protected])
