NEWS OPEC, its market share static, keeps wary eye on Iraq-U.N. talks

ARCO's U.K. North Sea Blenheim field is an example of how low cost methods-in this case the leased production vessel Petrojarl I-have enabled development of discoveries that once would have been classed as uncommercial. Blenheim holds reserves of 23 million bbl, which are being produced in a 31/2 year program. After that, the ship will move to another assignment.

Members of the Organization of Petroleum Exporting Countries are keeping a close watch on talks between Iraq and the United Nations on partial lifting of the U.N. ban on exports of Iraqi crude oil.

With a firm grip since 1990 on about 40% of the world oil market, OPEC production is inching toward a rebound. That slow progress could hit a roadblock when Iraq returns to the market.

A virtually static share of world oil supply and Iraq's return are causes of immediate concern for OPEC members, who increasingly look to higher oil revenues as a way to bolster their economies.

Clouding OPEC's long range outlook is the probable return of Iraq to full production and exports. How sharply that will jolt oil market shares and oil prices is anyone's guess.

Iraq-U.N. talks entered their second phase Mar. 11, but at Oil & Gas Journal presstime last week there had been no reports of progress. A first round of talks in February centered on U.N. terms for limited oil sales to pay for purchases of humanitarian supplies.

Middle East Economic Survey (MEES) said a host of technical issues need to be clarified in this second round, before political implications can be discussed in a further round.

However, a U.K. Foreign Office official said Mar. 13 relations between Iraq and the U.N. had become more difficult in the past few days.

That's because U.N. weapons inspectors were being impeded in their searches of Iraqi military installations. A full inspection of Iraq's arsenals is a condition of lifting of the U.N. oil export embargo against Iraq.

Analysts agree that the most serious problem for OPEC will surface when the embargo against Iraq is lifted and full oil exports can resume. This is seen as an inevitable consequence of U.N. approval of limited sales. It is expected to stir arguments among OPEC members over who must cut production to make way for Iraq.

Julian Lee, oil analyst at London's Centre for Global Energy Studies (CGES), said a positive outcome to the current Iraq-U.N. talks is increasingly likely, although there is still a long way to go before an agreement.

"We are looking at a couple of months before these things are sorted out," Lee said. "Then it will be up to the U.N. to put in place monitoring and banking requirements to enable limited oil sales.

"The end of the second quarter or beginning of the third is the most likely time for the start of limited Iraqi oil exports. Iraq appears to be doing whatever is necessary to ensure these talks finish satisfactorily, but no more."

Production, challenges

Oil & Gas Journal figures for most of 1995 place OPEC crude oil production at 25.607 million b/d, or 42% of world supply.

That share is down from 2 decades ago when the group's production of 27.073 million b/d accounted for a resounding 51% of world supply. But it is up sharply from 1985 when OPEC supplied only 30% of world crude.

The seesaw performance stemmed from advances and retreats in world oil prices.

Matching OPEC's grip on about 40% of the world crude market for the past several years, of course, is a claim to about 60% of the world market by oil producing countries outside the OPEC sphere. Non-OPEC oil production has averaged 35.948 million b/d since 1990.

OPEC leaders have a dual challenge:

• Mount a defense against another erosion of market share by non-OPEC oil producers.

• Place a rein on OPEC production to encourage an oil price hike.

  For the moment, OPEC's top brass are discussing whether the organization can survive in the face of mounting competition. Booming North Sea production, with further rises to come, is the largest immediate threat.

  Taken to the extreme, the current situation raises the question of what would happen if competition for markets by non-OPEC oil producers dismantled OPEC. There are a number of related issues, including whether:

• Non-OPEC producers would benefit if OPEC broke apart tomorrow.

• Non-OPEC production is as much of a threat to OPEC as the internal politics of OPEC members.

• OPEC or non-OPEC producers stand to gain most by Iraq's return to oil exports.

• OPEC is merely lying dormant rather than defeated by competition from non-OPEC production.

• In the long term OPEC and international oil companies will need each other to survive.

Analyst's view

The importance of Iraq's return to the market commands a great deal of attention from financial analysts.

For example, PaineWebber in mid-February gave investors this analysis of the situation:

• Oil prices will continue to be affected during the next several weeks by the direction of Iraq-U.N. talks over limited oil sales.

• Unlike past discussions, Saddam may now want to make a deal.

• Talks regarding distribution of aid to Kurds in northern Iraq likely will make or break a deal.

• Reentry of Iraq would highlight the emerging conflict between OPEC members that are producing within quota and those that are not.

While past negotiations on limited oil sales from Iraq have failed, PaineWebber pegs the chance at 70% that current discussions eventually will lead to return of Iraqi oil to world markets.

The New York investment firm said, "We believe the key factor different from discussions in April 1995 and June 1994 is Saddam Hussein's motivation.

"While Iraq historically has rejected terms for limited oil sales on the official grounds that they violate Iraqi sovereignty, the real reason may be much more basic. We believe Saddam Hussein refused to accept limited oil sales in the past in the belief that such an acceptance would detract from his efforts to have sanctions lifted permanently."

Today, Iraq finds itself in a much different situation, PaineWebber pointed out:

• Revelations after the Persian Gulf war on the extent of Iraq's weapons programs have all but eliminated the possibility of permanent lifting of sanctions in the foreseeable future.

• France and Russia, Iraq's past supporters in the U.N. Security Council, are no longer pressing for permanent lifting of sanctions.

• With his domestic economy collapsing and the prospect for permanent lifting of sanctions more remote than ever, Saddam may be willing to accept limited oil sales for humanitarian purposes.

A world without OPEC

OPEC Sec. Gen. Rilwanu Lukman gives this vision of a world without OPEC: "It would be characterized by instability, volatile prices, uncertain returns on investment in the industry, and the near impossibility of sensibly planning capacity expansion. And the non-OPEC producing countries would certainly not be able to enjoy the benefits of OPEC's market stabilizing actions as they do today."

Leo Drollas, CGES chief economist, reckons the world oil industry needs a residual supplier.

Before OPEC, major oil companies used their Middle East fields to act as swing producers to maintain oil prices. After the formation of OPEC, the same Middle East countries largely continued in this role.

"Someone has to be the swing producer," Drollas said. "If all countries produced to their capacity limits, the price would fall to $5/bbl. Then there would be drastic cutbacks, but the price would eventually rise again and when it reached about $15/bbl the countries would all raise production again.

"There would be a free-for-all among non-OPEC producers if OPEC collapsed. There would be a big problem in deciding which countries would take on the role of swing producers. We can't see any individual country being able to do it."

Drollas said the oil industry needs a core of four or five major producing countries to prevent an oil price crash, "so it would need to keep OPEC going."

OPEC's dilemma

Lukman wrote in OPEC Bulletin magazine that the big issue concerning the organization at present is non-OPEC production.

Lukman said the stabilizing effect on oil markets of production restraint by OPEC members is being undermined by lack of production restraint by non-OPEC countries, reducing oil prices and revenues of member countries.

Lukman said, "Technological developments such as horizontal drilling and 3D seismic surveying have today made it possible for non-OPEC countries to supply a greater proportion of the world's oil at a lower cost than was previously thought possible."

World oil demand is set to continue increasing during the next few years, Lukman said, but it appears to OPEC that most of the increase will be met by oil from outside OPEC, as has happened recently.

He said, "OPEC countries hold some 75% of the world's oil reserves, and it might therefore seem logical that they should provide the bulk of the world's future oil supplies."

Geoff Pyne, oil analyst at UBS Ltd., London, said OPEC's dilemma is that it can act either to protect market share or defend the oil price, but it will lose both ways.

Pyne said, "The problem for OPEC is that if it chooses to defend the price, this will only stimulate non-OPEC production, which in turn will further reduce OPEC's market share."

The normal wisdom used to be that there is a 4 year turnaround between significant rising prices and resultant oil production.

Pyne said, "Now lead times are shorter than people think-and getting shorter. If OPEC acts at one ministerial meeting to defend its price, it finds 1 year later that non-OPEC production has gone up.

"OPEC then has to decide whether to cut output to maintain the same price or continue producing at the same level and see lower prices. In the long run, the market wins. OPEC no longer has any control over oil prices in the long term."

Non-OPEC production

In recent years, technological advances have enabled operators to reduce development and operating costs.

This has encouraged a boom in oil production from areas such as the North Sea at the expense of OPEC. Similarly, growing Latin American economies have encouraged their oil industries.

Two recent reports have voiced differing outlooks for OPEC's biggest threat, North Sea oil. One offers more comfort for OPEC than the other.

Northwest Europe's oil production will peak at 314 million metric tons/year in 1998, says a report published by Mackay Consultants, Inverness, Scotland (OGJ, Feb. 26, p. 29).

Mackay data show world oil production has increased by nearly 11% since 1987, while the offshore contribution has increased by more than 36% during the same period.

Most of this growth in offshore oil and gas production has occurred in the North Sea, particularly off the U.K. and Norway. More recently, world offshore production increased by about 82.4 million metric tons during 1993-95. Of that increase, 75.7% came from the North Sea.

Mackay said, "In other words, the recent rate of growth in North Sea oil output has been nearly nine times that of the rest of the offshore industry."

"On present evidence," Mackay said, "1998 will be the peak year for North Sea oil production because we are forecasting a fall of about 2.6% in 1999. That will be welcome news for OPEC!"

This view contrasts with recent International Energy Agency (IEA) predictions that Northwest Europe's oil output will reach almost 350 million metric tons/year in 1999 and stay higher longer than earlier estimates held.

IEA said the common wisdom had been that North Sea production would peak in the mid-1990s and decline rapidly in the latter half of the decade, coinciding with similar decreases in North America.

EIA said, "Current predictions indicate that North Sea production will not peak until at least 1999 at a level over 7 million b/d, not including 515,000 b/d of natural gas liquids, which is 1.6 million b/d above the projected 1995 level.

"The peak is substantially higher and later than recent conventional wisdom would have suggested, with consequent repercussions for the medium term oil market.

"Any expected surge in the call on OPEC crude oil could be further delayed until sometime well after the North Sea peaks if experience and technologies that contributed to pushing out the North Sea peak accelerate their dissemination into other non-OPEC areas."

Last January, OPEC predicted world oil demand will reach 68.9 million b/d during 1996, MEES reported.

This was 66,000 b/d higher than OPEC's previous forecast and involved an increase in demand of 1.44 million b/d over 1995 production.

OPEC reportedly expects 1996 oil production outside OPEC to average 44.29 million b/d, an increase of 1.81 million b/d from last year's non-OPEC output.

Call on OPEC oil

MEES said OPEC expects the 1996 call on members' oil to be 25.6 million b/d in the first quarter, 23.4 million b/d in the second, 23.7 million b/d in the third, and 25.7 million b/d in the fourth.

CGES said in January that if OPEC's total production continues at about 25.4 million b/d, world production will outstrip demand. Buyers will need to build stocks at 2 million b/d during the second and third quarters, which goes against the trend to minimize stockholding.

CGES said, "OPEC members need to act almost immediately to maintain last year's average price of $16.90/bbl in 1996. If they could restrict their combined output to 25 million b/d from second quarter onward, the average price of the OPEC basket in 1996 would be similar to last year's."

CGES predicts the most likely 1996 averages for OPEC basket crudes will be $17.10/bbl in the first quarter, $17.60/bbl in the second, $16.40/bbl in the third, and $14/bbl in the fourth.

Recent OPEC figures suggest some members are producing as much as they can in a bid to make money short term. Only Iran's tendency to underproduce has kept production down some months.

OPEC production averaged 25.14 million b/d last December, down 210,000 b/d from November. But MEES said the fall was due mainly to a reduction of 245,000 b/d in Iran to 3,355 million b/d, significantly below its 3.6 million b/d quota.

Nigeria has been raising production further above its quota after technical and political problems last year. Venezuela remains the most blatant quota violator, producing an excess 441,000 b/d in December.

OPEC production for 1995 averaged 25.116 million b/d, up 330,000 b/d from the 1994 average. This was due mainly to a hike of almost 200,000 b/d in Venezuela, whose government is desperate for oil revenue.

In January, however, OPEC production reached its highest level for some time. It averaged 26 million b/d, a hike of 860,000 b/d from December.

MEES said the increase was due mainly to Iran, which boosted production by 685,000 b/d in January to an average 4.04 million b/d.

MEES said about 200,000 b/d of Iran's monthly average increase stemmed from loading delays at Kharg Island in late December due to bad weather.

Nigeria continued to claw back lost revenues, raising production by 40,000 b/d to an average 2 million b/d in January. And Venezuela continued in its role as chief overproducer, with an average 100,000 b/d increase to 2.9 million b/d.

OPEC politics

Drollas maintains that non-OPEC producers could not kill OPEC, but OPEC countries' internal political problems could. All the countries with large reserves face grave political problems.

Drollas said, "There is a big question over whether Iraq will be around in 10 years' time because anything could happen when Saddam goes. Iran has severe political troubles ahead, Saudi Arabia has problems, and Kuwait is sandwiched between Saudi Arabia and Iraq."

A major concern in all those countries is rising Islamic fundamentalism, with fundamentalist governments expected to be unwilling to raise oil production to meet the needs of the outside world.

"It is most likely to be a political issue if a country decides to quit OPEC," Drollas said. "Saudi Arabia and the others could be convulsed by an Islamic fundamentalist revolution, and this could restrain production even more.

"But the bottom line is that OPEC won't disintegrate unless its big members pull out. Nor would OPEC split because of a price crash. When the price gets down to around $12/bbl, members all step in line.

"There is unlikely to be a collapse of OPEC because of Iraq's return to full production either. The danger of the moment would focus other members' minds."

Edward N. Krapels, president of Energy Security Analysis Inc., Washington, says despite its internal problems OPEC will be around for years to come.

"OPEC is like a possum," Krapels said. "It looks dead, but it's not. And from time to time it wakes up and does something interesting. OPEC will become more interesting as a political force when and if Iraq returns because Iraq is likely to catalyze OPEC's core members."

Meantime, Krapels reckons paper markets-not OPEC-control oil prices: "OPEC could reemerge. But so long as non-OPEC production continues to rise, OPEC will continue to play possum."

While Iraq and the United Nations decide their next moves in talks over limited oil sales, OPEC members have begun to argue about how they can accommodate Iraqi oil.

CGES said, "Tehran has called for Riyadh to bear the burden as a major beneficiary of Iraq's enforced absence from the market, while the U.A.E. has joined Saudi Arabia in calling for strict quota observance as the obvious way to accommodate Iraqi oil.

"Given the levels of overproduction currently enjoyed by some member countries, there will have to be a major price crisis before members will withdraw from their entrenched positions."

The future of OPEC

The strongest arguments for a strong future OPEC are its members' oil reserves and the fact that non-OPEC production will decline long before some OPEC members' reserves begin to wane.

Colin J. Campbell, associate consultant for Petroconsultants SA, Geneva, reckons the world oil industry has produced 750 billion bbl and has about 1 trillion bbl left to produce. About 23 billion bbl is produced each year while output is rising, and less than 7 billion bbl a year is being found.

In a country by country depletion forecast, Campbell classifies producing nations according to when half their reserves have been produced, which he said usually coincides roughly with peak production.

U.S. is past its peak, but most countries have not reached the half way point. Saudi Arabia, Kuwait, Iraq, Iran, and Abu Dhabi are well short of the half way point and own more than half the world's remaining oil.

Campbell said, "However, 20 or so countries are a year or so from their peak and will soon enter a decline. The five Middle East producers will peak about 2015, while the rest of the world will peak about 2000."

Many countries are producing near peak, Campbell said, and are running out of abundant, cheap supplies of oil. He expects the five Middle East countries to produce 60% of the world's oil by 2010, up from 27% today.

For the meantime, though, non-OPEC producers hold the key to OPEC countries' incomes. This may lead to a reversal of the situation that inspired establishment of OPEC in the first place.

OPEC's Lukman said, "Burgeoning non-OPEC production is effectively limiting the oil revenues of our members, thus imposing an artificial cap on the amount of capital they can set aside for investment in capacity expansion that will surely be needed over the next few years to meet growing demand for oil.

"If this issue is not addressed in a responsible manner by all the parties, the outcome could be a supply crunch some time in the not too distant future."

Full circle

OPEC was formed after a meeting of governments of five countries-Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela-in 1960.

In those days, the world oil price was set by international oil companies that produced in those countries. The meeting set out to discuss protection of the countries' assets after oil companies imposed a series of cuts in prices for Middle East and Venezuelan crudes.

Qatar joined the newly formed OPEC in 1961, followed by Indonesia and Libya in 1962, U.A.E. in 1967, Algeria in 1969, and Nigeria, Gabon, and Ecuador in the 1970s. Ecuador left OPEC in 1992.

Many of those countries nationalized their oil industries during the 1970s, taking control of assets until then operated by major oil companies.

Now it appears that partnerships with foreign oil companies may be the best way for OPEC members to finance their planned oil field developments and gain access to state of the art techniques in exploration, drilling, and production.

"The wheel has turned full circle," Lukman said, "and a number of our members are now working together with western oil companies. The precise form of cooperation adopted between countries and companies naturally varies from case to case.

"Our members fought hard to gain sovereignty over their hydrocarbon resources, and it's not something they would be willing to surrender lightly. Nevertheless, there is a recognition of the fact that partnership and cooperation with oil companies may be the best way forward for some members."

CGES' Drollas said that while non-OPEC production will continue to rise for some, the industry will need more OPEC oil to survive sooner or later.

"The IEA report threw a spanner in the works," said Drollas, "by saying that the world would not need any more OPEC oil production before 1998, but we are certain that by 2000 the call on OPEC production will be about 29 million b/d."

If Iraq has not returned to full oil exports by then, Drollas said, there will be "quite a tightness" on use of OPEC's productive capacity.

"Looking beyond to 2005," Drollas said, " we are talking about 37 million b/d OPEC production being needed, which is almost 12 million b/d above today's production."

This represents a large requirement for additional OPEC oil, which could be a problem because only four or five OPEC members can increase their production significantly.

"Iraq is the main one," Drollas said. "Without Iraq there will be trouble, but the country should be producing more than 5 million b/d by 2005. Then Saudi Arabia would be producing well over 10 million b/d, Iran about 4.3 million b/d, and Kuwait around 3.3 million b/d."

Countries that will not be playing a significant role by 2005, Drollas said, are Qatar, Libya, Algeria, Gabon, Nigeria, and Indonesia. "And there is a big question mark over Venezuela."

Drollas said Venezuela's interests, unlike other OPEC members, lie in promoting trading interests in the Western Hemisphere, and the country's state oil company is more like an oil major than any other state company in OPEC.

Copyright 1996 Oil & Gas Journal. All Rights Reserved.