The oil market`s buoyancy is beyond the wildest dreams of most oil executives, and what`s more, market fundamentals are beginning to justify the recent surge.
This is the view of London`s Centre for Global Energy Studies (CGES), which said that the oil market is actually overheating, making a rise in output from the Organization of Petroleum Exporting Countries welcome.
The price for Brent crude oil has been in the $18-19/bbl range for several weeks now, and in London trading on July 19, the closing prices were $19.70/bbl for dated Brent and $19.35/bbl for September-delivery Brent.
"We are now entering a period in which the fundamentals are at last pointing oil prices in the same direction as the futures market has been doing for some months," said CGES. "OPEC`s cuts have finally made their expected hole in long-haul crude supplies, summer maintenance in the North Sea is in full swing, crude runs are rising on the back of positive refining margins, and product stocks are just beginning to decline.
"There is indeed a genuine shortage of crude in the Atlantic Basin at a time of unrest in the Niger Delta and an improving rate of compliance from OPEC, so a strong prompt price rally was to be expected, with Brent leading the way."
The latest OPEC production estimates from Middle East Economic Survey show a compliance level of 89% with the OPEC cutbacks agreement made in March (Table 1). MEES attributed the production decline to an average 25.84 million b/d in June from 26.31 million b/d in May largely to reduced Iraqi output. This was caused by administrative delays in transferring from one 6-month phase to another of the United Nations-brokered oil-for-aid agreement.
Stock drawdown
CGES said that, if worldwide production were to continue at its current level, there would be an enormous stock draw of 2.9 million b/d in the fourth quarter, which would bring global stocks to a level last seen in early 1997, when Brent crude was trading at $24/bbl.
Simmons and Co. International, Houston, expressed a similar opinion in a recent crude oil forecast.
"We believe it is important to start thinking about how OPEC will react to continued worldwide crude oil demand growth and the continued impact of reduced drilling activity on non-OPEC supply," said Simmons`s David Pur- sell.
"The ability to increase non-OPEC production is significantly impacted by capital spending and drilling activity levels," Pursell said. "We estimate EandP capital spending will be down 25% in 1999, resulting in a 1999 decline in non-OPEC production of 1.0 million b/d. As we look at the available preliminary 1999 production data, we see no compelling argument to change our 1999 forecast. The international rig count has declined more than 25% from early 1998 highs, and we do not expect significant improvement until early 2000."
Simmons predicts that, if non-OPEC supply continues to decline through 2000 and global demand growth is modest, the current inventory overhang will be gone early in the fourth quarter (see chart). Simmons assumes that all the inventory change will take place in Organization for Economic Cooperation and Development countries.
"Crude oil prices will likely rise long before the OECD inventories break through their recent historic minimum levels, as nearly 45% of the inventory overhang is in middle distillates," said Pursell. "As crude oil and motor gasoline inventories are reduced during third quarter 1999, there will be significant upward price pressure as the market reacts to the market tightness of the individual products."
OPEC output
With companies in non-OPEC countries holding back on new developments, says CGES, stagnant non-OPEC oil supply in the face of an anticipated rise of 1.1 million b/d in worldwide oil demand this year is a source of concern.
"The oil market is clearly overheating," said CGES. "With prices heading above $20/bbl, logic dictates an increase in OPEC production to underpin demand growth and forestall a resurgence in non-OPEC production." Simmons also sees increased OPEC production as the key to preventing excess oil market tightness in the coming year.
"We think OPEC will be compelled to relax their quotas as inventoriesellipse(are) worked off early in the fourth quarterellipse," said Pursell. "The same market that currently seems uneasy with the possibility of OPEC raising production will signal a tight supply and demand situation through higher oil prices.
"Although it may seem early for a 2000 forecast, it is important to try to understand how much production OPEC will have to return to the market in 2000 to balance supply with demand," he added. Simmons predicts an increase in OPEC output in fourth quarter 1999 and first quarter 2000 (Table 2).
"OPEC will need to increase 2000 production 3.6 million b/d to 29.7 million b/d, compared with second-quarter 1999 estimated production levels," said Pursell. This forecast assumes a 1 million b/d decline in non-OPEC supply in 1999 and a further 400,000 b/d fall in 2000. Those declines would occur concurrently with an 800,000 b/d increase in worldwide oil demand in 1999 and a 1 million b/d rise in 2000, according to Simmons`s forecast.
The timing of any OPEC response to improved prices is key, says CGES.
"OPEC has a chance in September to prove that it can manage prices sensibly. An announcement in Vienna that OPEC`s output will rise by at least 1.5 million b/d from April 2000 onwards would help calm down the market, but do not count on it."
CGES says that the size of any OPEC increase and the timing of its announcement would have a profound effect on oil prices in 2000; but OPEC is not expected to increase output before April, as it waits on proof that oil inventories have fallen.
"The most likely time for the organization to agree and announce an increase," said CGES, "would be at its regular meeting in March 2000. An output increase of 2 million b/d, taking total OPEC output to 28.2 million b/d from April 2000, would serve to halt the rise in oil prices that we expect to see over the coming winter."
CGES says that, in this case, the price for dated Brent would average $18.30/bbl in the third quarter, $20.80/ bbl in the fourth quarter, $20.80/bbl in first quarter 2000, $19.10/bbl in the second quarter, $18.20/bbl in the third quarter, and $17.40/bbl in the fourth. This course of action would yield an average dated Brent price of $18.60/bbl in 2000, which would be within OPEC`s target price range.
"The maintenance by OPEC of oil prices around $18/bbl for Brent," said CGES, "would send a very clear message to the world`s upstream oil companies that it was once again safe to invest in exploration and development; it would also provide them with the cash to do so."
