The oil market now depends on weather and the president of Iraq.
The Organization of Petroleum Exporting Countries didn't do enough last week to realign the supply of oil with demand. The 800,000 b/d quota increase OPEC ministers announced after their brief meeting in Vienna won't replenish global oil inventories, which are now abysmal. It won't even balance the market at recently projected levels of demand for the year's fourth quarter. Price will have to do the job. If weather is normal, oil consumers in the Northern Hemisphere face a long winter.
The arithmetic
Arithmetic makes the predicament clear. In August, the International Energy Agency projected average fourth-quarter oil demand at 78.5 million b/d and non-OPEC supply at 46.6 million b/d. That leaves 31.6 million b/d for OPEC. Of that, 2.9 million b/d of natural gas liquids falls outside the group's quota. So does Iraqi production, slumping lately to about 2.5 million b/d.
Just to meet demand at IEA's August projection for next quarter-the estimate available to OPEC ministers in Vienna-therefore, OPEC needs to produce 26.5 million b/d of crude. The quota adjustment makes non-Iraqi OPEC output short by 300,000 b/d.
Normally, oil from storage might make up the deficiency. But inventories are so low now that the market can't handle any sort of supply disruption. They're not going to yield 300,000 b/d for the entire winter.
The chance exists, of course, that winter will follow the recent pattern of abnormal warmth. Demand then would fall below IEA's projection. But that's a flimsy hope. Oceanic phenomena thought to have caused winter warmth have dissipated. The industry must prepare for normal weather or worse. So must its consumers.
That leaves Iraq. The maverick OPEC member can produce as much as 3 million b/d. How long it can sustain output at that level is open to question. The rate recently was lower because of logistical problems and a pause associated with the biannual reinstatement of Iraq's humanitarian exemption from United Nations sanctions.
A full 3 million b/d from Iraq would give the market what it needs if IEA's demand projection comes true: enough oil to meet immediate need plus 200,000 b/d to restock. While that's no great inventory build, it beats a 300,000 b/d pull on storage already dangerously low. The OPEC production accord thus hands Iraqi Pres. Saddam Hussein an interesting lever with which to manipulate welfare of the world's oil consumers.
The market never holds still, of course. Traders know shortage when it's pounding against the walls of empty tanks. On news of OPEC's half-measure, crude prices leapt. If they remain high, fourth-quarter demand won't reach IEA's projected average. In fact, IEA's September Oil Market Report, released after the OPEC meeting, reduced the projected level by 100,000 b/d. Meanwhile, the price strength should coax more crude out of non-OPEC producers so far reluctant to expand their operations.
No matter what OPEC decided in Vienna, heating fuel was destined to be expensive this winter for consumers in Europe and the US. The problem is processing capacity. US refiners continue to run at 96-97% of capacity, European refiners somewhat lower but with little idle upgrading capacity. To produce enough distillate to both rebuild inventories and meet demand now seems impossible. Refiners will be busy just meeting demand. The price, therefore, will be high. And any disruption to the supply system will of course aggravate the problem.
A larger production hike from OPEC wouldn't have solved the volumetric challenges for distillate this winter. But it might have eased the cost of raw materials for refiners and the price outlook for consumers.
European taxes
OPEC officials used their announcement of the quota adjustment as an opportunity to lambaste high taxation of oil products in Europe. It's a longstanding complaint-and a valid one. But pressing the point while denying the market needed oil looks like political manipulation. OPEC does itself no good when it behaves this way.
In any event, producers have earned a few quarters of healthy profitability. Most of them went much longer than that with profits thin or nonexistent. But they should prepare for political trouble. And they know better than to expect good times occasioned by levitated crude prices to last forever.
