Oil price defies gravity

David Knott
London
[email protected]

Like a magician's levitation act, the behavior of crude oil prices has appeared to defy gravity since producers slated output cuts in March.

At the close of London trading on Apr. 19, both dated Brent crude and June delivery Brent stood at $16.09/ bbl, a rare equilibrium and the first time in more than 1 year that Brent has topped $16/bbl.

While early in the year, Brent futures prices wallowed around $10/bbl, the current market strength resulted from a deal between the Organization of Petroleum Exporting Countries and Mexico, Norway, Oman, and Russia to cut output further by 2.1 million b/d (OGJ, Mar. 29, 1999, p. 18).

London's Centre for Global Energy Studies (CGES) says that OPEC's euphoria after the Vienna meeting seems fully justified, with subsequent prices far better than anyone expected.

"Oil prices have put on $2/bbl since then," said CGES, "and $4/bbl since early March, with hardly a barrel being cut. Expectations have played a key role in this story."

Good news diet

Optimism among oil traders helped futures prices to rise, and this also pulled up spot prices despite a glut of prompt cargoes.

"However," said CGES, "with such huge long positions open, prices need a steady diet of good news to stay buoyant. News that compliance is wobbling could cause a swift price correction."

This happened on early reports that Venezuela would not be able to meet its target to reduce output, as promised, as of Apr. 1. Oil prices immediately began to tumble, but recovered when Venezuela denied the reports.

Like any audience of a magician's act, the oil industry is looking for hidden wires. CGES identified support for the unexpectedly high oil price from traditional friends of oil industry: weather and warfare.

"OPEC's tightening of the screw," said CGES, "has been helped by cold snaps in Europe and the U.S., while NATO's bombing of Serbia is said to have boosted jet fuel consumption by 200,000 b/d."

CGES added that South Korea's year-on-year oil demand surged in the first quarter, while U.S. gasoline demand in February was up 6.4% from February 1998, and German distillate sales boomed in anticipation of a tax hike.

Causes for concern

On behalf of industry's spotters of hidden wires, CGES identified a number of causes for concern about any glowing future for oil prices.

"Due to smoldering resentments," said CGES, "OPEC's new-found solidarity is unlikely to be enough to guarantee full compliance. One problem is the unequal cuts required of the OPEC countries.

"For example, with full adherence, Venezuela's year-on-year output cut is 12% vs. Iran's 5%. Another is the great imbalance of idle capacity within OPEC-Saudi Arabia accounting for 47% of the total vs. only 6% for Iran and Nigeria and 12% for Venezuela."

Yet even if compliance with the cutbacks deal is only 77%, CGES reckons increasing oil demand will lead to a global oil stock draw of 1.1 million b/d this year.

Behind this positive outlook, however, CGES found a hidden wire which might actually turn out to be a trip-wire: "With the call on OPEC oil exceeding its projected supply, OPEC could get over-confident."