Markets will cycle through the tightness that has elevated prices of crude oil and petroleum products this year. What they don't need are avoidable wild cards.
The broad forces influencing oil prices are demand strength, inventory weakness, and declared production restraint by the Organization of Petroleum Exporting Countries. Variables difficult to predict wiggle within each. And with one of them, inventories, consuming-country governments have more influence than they've so far been willing to exert.
Role of demand
Prices can't and won't rise forever. At some point, demand will subside. Some of the effect will be from consumption restraint driven directly by price. Some will come from broader economic phenomena as price increases for steel and other commodities besides oil slow global expansion. China can't keep growing—and absorbing oil, steel, and other commodities—at its recently high rates. Indeed, the Chinese government has begun trying to chill what it sees as an overheated economy, raising concerns about a reactionary recession.
Demand in the next few months, is thus crucial and difficult to predict. The mistake to avoid, as always, is expecting the future to be a continuation of the present.
OPEC seems willing to overproduce its reduced Apr. 1 quota of 23.5 million b/d to supply what the market needs—within limits. The US Energy Information Administration noted at the end of April that OPEC could lower crude prices by raising production and charging less. In fact, EIA said, crude buyers have rejected offers by exporters of extra oil because the price is too high. Although inventories in the US remain very low in relation to consumption, recent prices discourage purchase for storage. If extra oil were offered at lower prices, "some companies would add discretionary barrels," EIA said.
Yet an already nervous market would have reason to become more so if OPEC's producers with spare capacity raised output now in a deliberate attempt to lower price. Such a move would transfer oil from one of the market's two safety cushions to the other. Both cushions—spare production capacity available on short notice and oil in storage and known to be available—are perilously thin.
The market, in fact, would exhaust those buffer supplies quickly if production ceased in Venezuela, Nigeria, or Iraq. Recent production from each country exceeds the 2.1 million b/d that EIA estimates for spare production capacity that could be brought on stream within 30 days by OPEC members. The market has lost production from each country at least once within the past 2 years. And one of them, Venezuela, has a leader openly antagonistic to the US.
Another buffer exists, though. It's oil in strategic storage. On May 3, the US had 658 million bbl in the Strategic Petroleum Reserve. In an emergency, the SPR can bring crude to market within 13 days. It can sustain deliveries at the maximum rate of 4.3 million b/d for 90 days. The president, within statutory guidelines that give him great latitude, decides what constitutes an emergency.
Clarification needed
Wise though it be to preserve official prerogative, clarification would be useful now. EIA's scenario, more crude available from OPEC at a price low enough to induce hoarding, is certainly hopeful and might be unfeasible. Because the extra crude would have to come from idle capacity lately unable to cover contingencies the market must heed, the new production might, in fact, not lower price at all unless consumption slumped at the same time. What's more, erosion of the capacity cushion would be dangerously tempting to terrorists hoping to disrupt western economies or to producing-country governments interested more in global mischief than oil revenue.
In an oil market as strained as that of first-half 2004, disruptions like those would represent emergencies. The US president and his counterparts in other countries with strategically stored oil should say so now. It would confirm an important relief supply about which the market now must guess. And it would discourage international mavericks from trying to deploy the oil weapon. It's toward the latter purpose that the SPR and related programs by other members of the International Energy Agency have been most effective in the past. The market needs a reminder that consuming countries know how to use the tool.