Room to fall

Aug. 25, 2008
Although the oil market has lost nearly 1 million b/d of strategic transportation capacity, the price of crude oil is falling.

Although the oil market has lost nearly 1 million b/d of strategic transportation capacity, the price of crude oil is falling. Something has changed.

Only a few months ago, a mere rumor about disruption to that much oil movement would have panicked traders and sent the crude price upward. Yet the market all but shrugged off shutdown of the Baku-Tbilisi-Ceyhan oil pipeline early this month after a fire and the outbreak of war between Russia and Georgia, which the BTC line crosses.

Other outlets

The BTC pipeline fire broke out Aug. 6 in Turkey as throughput of light crude, most of it from fields off Azerbaijan operated by BP PLC, was climbing toward an August target of 910,000 b/d. Tanker loadings in the Mediterranean ceased Aug. 7 after storage fed by the pipeline at Ceyhan ran dry.

Other outlets for Azeri crude from the Caspian include whatever capacity is available on a 155,000 b/d pipeline between Baku and Georgia’s Black Sea port at Supsa and on the 100,000 b/d pipeline between Baku and Novorossiysk, Russia. Both those routes rely on tanker transport across the Black Sea and through the congested Bosporus Straits, a bottleneck that BTC was designed to bypass, along with Russia, Iran, and Armenia. About 120,000 b/d can be moved by rail from Baku to Georgia’s port at Batumi.

At this writing, the Russian government’s intentions for Georgia were unclear. Moscow had agreed to a cease-fire but acted in no rush to withdraw troops from the break-away regions of South Ossetia and Abkhazia, over which hostilities initially flared, or from other parts of the country into which its forces had advanced. As a precaution, BP shut the Baku-Supsa oil line as well as the South Caucasus pipeline, which carries natural gas from the Caspian along much of the BTC route. Timing of repairs to the fire-damaged portion of the BTC line was uncertain. Assuming that the pipeline remains down through August and gradually restarts in September, the International Energy Agency cut its forecast for oil production from Azerbaijan by an average of 260,000 b/d for the third quarter and by 65,000 b/d for all of 2008.

As supply disruptions go, this doesn’t rank with, say, the politically related halts to exports from Nigeria and Venezuela in 2002 or the hurricane jolts to Gulf of Mexico production in 2005. It was still enough to be alarming. If anything, the pipeline explosion and Georgian military action provided little more than a pause at about $115/bbl in a crude-price swoon that began from a peak of $147/bbl for New York Mercantile Exchange futures in mid-July. By Aug. 19 the price had fallen below $113/bbl.

Several conditions that had been lifting the crude price have eased. Large among them is weakness of the US dollar. Some analysts have scoffed at the dollar’s effect on recent crude-price movement. But the month-long price decline coincides with a 9% dollar-value gain against the euro. Reinforcing the correlation, the crude price jumped on Aug. 19, when the dollar’s value took its biggest dip in a month. Also starting in mid-July, stock-market indicators gained ground while commodities generally fell. A rush of investment funds into commodities and away from other assets has been cited, like the weak dollar, as an extraordinary factor in elevated oil prices.

Fundamentals changing

Market fundamentals, too, are changing in ways that ease pressure on crude prices. Demand growth is diminishing worldwide, occurring mostly in developing countries, a number of which are dismantling product-price subsidies. And long-awaited production projects large enough to materially raise global oil supply are coming on stream or are expected to start up soon.

It is, of course, too early to tell if relaxation of the forces that had pushed oil prices to record levels are temporary adjustments or elements of a price decline likely to last awhile. A tepid response to events in Turkey and Georgia indicates that the market—that is, the collective net judgment of all buyers and sellers of oil—thinks prices have more room to fall.