Oil traders face an interesting test. And oil producers who still think traders set the price of oil are witnessing an enlightening reassertion of market fundamentals.
The market is changing rapidly. Demand continues to rise despite last year's price gains. Inventories are draining. An end is in sight to the unusually large contribution stocks have made to supply for more than a year. To meet demand at projected levels, members of the Organization of Petroleum Exporting Countries will have to increase production. And they will have to do so fairly soon.
The fundamentals shift
The challenge for traders is to recognize the shift in market fundamentals. OPEC members as a group need to produce more than 23 million b/d, the collective quota since last Apr. 1. Because crude oil values in the past year have depended on historic compliance with that limit, the first sign of change might create panic.
Yet it has to happen. And it might happen the messy but normal way, with individual OPEC members able to do so quietly exceeding their quotas. Traders and non-OPEC producers just need to recognize that the world needs the oil.
In its annual Forecast & Review special report next week, Oil & Gas Journal will estimate the average global need for OPEC crude oil for all of 2000 at 27.9 million b/d. The forecast derives from late 1999 projections by the International Energy Agency for average oil demand in 2000 of 77.1 million b/d. It assumes an average stock draw for the year of a hefty-maybe too hefty-1 million b/d and an increase in supply outside of OPEC of 800,000 b/d.
A large remaining question is production by Iraq, now exempt from OPEC limits and free of the revenue limits formerly imposed by the United Nations. Oil field repairs should enable the country to increase output capacity toward its announced 3.5 million b/d target by the end of the year. But politics will guide production decisions by the maverick regime of President Saddam Hussein, who is said to have profited heavily from illicit oil sales during the United Nations regime of export sanctions. So there might be more politically motivated interruptions to Iraqi flow such as those of late 1999. A best guess for average output from Iraq: 2.5 million b/d.
For OPEC members subject to quotas, that leaves 25.4 million b/d on average for all of 2000. It says the world needs 2.4 million b/d more crude oil from OPEC than the current quota allows.
The question of the moment is whether OPEC will adjust the quota to these new realities or simply adjust production and leave the old quota in place. The other option-underproducing against the call on OPEC crude to kite the price of oil-would be self-destructive. The market would find an orderly and visible quota adjustment most comfortable. But OPEC might have other ideas.
A quota adjustment involves dicey politics and a possibly embarrassing public dispute over economics. OPEC would have to apportion increases among members united only by the availability of idle production capacity and the memory of 1998's fiscal pain. A quota adjustment also requires a very difficult economic judgment: a contemporaneous estimate of the call on OPEC crude at the approach of the year's second quarter, when demand always sags.
Least resistance
For OPEC, unannounced production increases in defiance of quota might amount to the path of least resistance. In the absence of economic consensus, they also might represent the best gauge of the market's immediate need for OPEC crude. The group can always adjust quotas later to fit production reality. It has worked that way in the past.
What is important is not OPEC's degree of compliance with a quota no longer valid. What is important is OPEC's continuing to supply a growing market that-as rising prices show-most definitely needs more oil. Failing to do so would help no one, least of all OPEC members. And no one else should worry too much if the needed supply emerges the messy but normal way.
