Handwriting on the wall for a 'soft landing' for oil prices?

Consuming nations have fired the first warning shot across OPEC's bow, and the handwriting seems to be on the wall for the speculated "soft landing" for oil prices in the second half.

Despite recent comments by some OPEC oil ministers that a 9-month rollover of the current production cuts accord might be appropriate or that $25/bbl is a reasonable price for oil, there was a flurry of activity among oil ministers this week in the wake of the decision by US Energy Sec. Bill Richardson to undertake a swap of crude oil from the Strategic Petroleum Reserve in exchange for future refills.

Richardson's plan calls for the release of millions of barrels of crude oil from the reserve in an exchange with US oil companies. The companies, in turn, would bid for the oil and replace it within a year-earning a premium for additional barrels of oil to be stored in the SPR.

This is a clever back-door way of using the SPR to put more oil on a tight market and thus take some of the heat out of oil prices for the moment-without running afoul of a congressional mandate not to draw down oil from the SPR except in the case of a genuine supply emergency. (Speaking of which, a lot of "heat" has been directed lately at the Clinton administration and at Richardson in particular over spikes in heating oil prices during a brutal cold snap in the US Northeast; the timing of the SPR swap plan was certainly no accident).

Richardson denied he was putting forth the plan in order to pressure OPEC to relent on production-cut adherence at a time when oil prices have been flirting with $30/bbl. But that begins to sound a bit disingenuous when one notes that he followed up the plan's announcement with visits to OPEC members nations and to Norway (an adherent to OPEC's production cut regime) this week, and plans to visit Saudi Arabia this month. What better time to jawbone OPEC into relenting on production cuts than when armed with an imminent release of strategic stocks onto the market? As further evidence of jawboning, Richardson, during a visit to Norway, reiterated the comment that he thought the price of oil is too high.

In fact, it could be argued that the comment by UAE oil minister Obaid bin Saif al-Nasseri that the current price of oil ($25/bbl for OPEC's basket of crudes) is realistic could be construed as a bearish signal for oil prices. Remember that oil prices were again headed for $30/bbl before Richardson announced the SPR swap plan. Al-Nasseri followed his comment with this addendum: "We obviously don't want to see prices jump too high, nor below expectations. We look forward to seeing a stable and balanced price that does not exaggerate the price formula both ways."

Sounds like code for engineering a soft landing, doesn't it?

Adding strength to this scenario is the latest report from the American Petroleum Institute regarding petroleum stocks. API says that US crude oil stocks, for the week ended Jan. 28, have plummeted to their lowest level in more than 20 years. In the latest report, US crude stocks fell by 10.4 million bbl to 281.2 million bbl, the lowest since the August 1976 level of 277.3 million bbl.

All along, OPEC has been saying that it is looking for signs that the massive oil stock overhang of 1998 and early 1999 is finally gone before it considers boosting production again. A 20-year low in US crude stocks amid a surge in winter heating demand is a pretty good sign.

But this is not to say that the API report and Richardson's proposal are enough to send OPEC scurrying for cover and flooding the market again. The UAE minister's comment came just after the Kuwaiti oil minister declared that the collective urge to extend production cuts for 9 months beyond the end of March (the scheduled expiration of the current product cuts accord and the date of the OPEC ministerial meeting in Vienna) was very strong. A good way to read this is that some in OPEC have seen the handwriting on the wall regarding SPR swaps and API stock data but want to get in a little jawboning (of prices upward) ahead of the Vienna meeting, seizing as much additional "economic rent" while they can. At the same time, others in OPEC want to make conciliatory noises to consuming nations about "fair" and "reasonable" prices, ostensibly to head off any more drastic action, such as a release of IEA stocks to cool off markets.

So what's the upshot of all of this? My guess is that OPEC will vote to roll over the production cut accord for the second quarter-but no further. Rather than spike prices, however, look for a dip in prices-not a big one, but a noteworthy one. That's because much of the heat in markets is hype-the market psychology that drives commodity prices through anticipation. Look for more conflicting comments out of OPEC in the next 2 months: jawboning prices upward with talk of a 9-month rollover (which even OPEC must realize would push prices to a level the group doesn't want, given the concomitant effects on demand and non-OPEC supply-not to mention the global economic boom that's under way) but also dropping hints about a soft landing for oil prices to head off retaliatory actions by consuming nations. So when the Vienna meeting ends with a rollover just through the second quarter, relieved markets will pull prices back down. A likely range would be $20-22/bbl for Nymex, with the higher end of the range coming during the peak pull of the summer driving season and the almost inevitable but unforeseeable minor threats to supply disruptions (Saddam Hussein can usually be counted on for at least a few of these per year now). That would be an ideal price level-high enough to help OPEC continue replenishing financial reserves but low enough to keep non-OPEC E&D budgets at a reasonable level, economies humming, and demand growth healthy.

If OPEC can demonstrate success with this approach, it could readily evolve into a model for future supply management that could mean an era of relative stability for oil prices (at least until Saddam really acts up again, that is).