The oil market fell subject to more tugs and pushes than usual last week as the Organization of Petroleum Exporting Countries acted to support the price of crude and the second hurricane in 2 weeks threatened production and refining in and near the Gulf of Mexico. It was enough to make the unattentive forget that the fundamentals of supply and demand have taken a sharp turn.
It was with an eye on that turn that OPEC on Sept. 10 agreed to lower group production to the target set a year earlier for members other than Iraq. After adjustments for new members Angola and Ecuador and departing member Indonesia, the target became 28.8 million b/d. That’s 570,000 below August production reported by the International Energy Agency for OPEC members other than Indonesia and Iraq. Noncompliance by overproducers such as Iran probably will keep the actual size of the announced cut closer to 530,000 b/d.
No surprise
That OPEC trimmed output should surprise no one. But overreaction is inevitable—and not just by analysts. OPEC’s move might revive discussion of a proposal in Congress to subject the exporters’ group to federal antitrust enforcement. The threat of a presidential veto has so far kept that nonsense in check. But antagonism toward OPEC will surge, however illogically, if Hurricane Ike, unlike Hurricane Gustav at September’s start, damages production and refining systems enough to raise gasoline prices.
The mere possibility of supply interruption, however, no longer sends oil prices into orbit. Prices responded minimally to Russia’s invasion of Georgia and Hurricane Gustav’s sweep over the Gulf Coast. The market’s new insouciance shows that something major has changed (OGJ, Sept. 8, 2008, p. 18). Indeed, as OPEC damped production and Hurricane Ike entered the gulf, evidence of that change strengthened.
IEA on Sept. 10 trimmed its projection for 2008 oil demand again, by 100,000 b/d. The new forecast of 86.8 million b/d is 1 million b/d less than what IEA was projecting in January. Demand at the newly projected level would be up just 0.8% from last year’s consumption. And IEA forecasts a demand increase of just 1% next year.
While demand growth sags, potential supply finally is growing. Saudi Arabia is bringing giant Khursaniyah oil field on stream after months of delay related to gas processing facilities. The field is expected to reach capacity output of 500,000 b/d early next year. By the end of 2009, total Saudi production capacity is to be 12.5 million b/d, 1.85 million b/d more than its level before Khursaniyah started up. IEA raised its September capacity estimates for Angola, where new fields have come on stream in the offshore Kizomba C complex, and for Iran, which has been producing as much as 4.1 million b/d. With new fields ramping up production, IEA expects OPEC capacity to climb by a further 500,000 b/d by yearend.
The combination of diminished OPEC production and increased OPEC capacity will thicken one of the oil market’s two important buffers against demand surges and supply shocks. Effective spare production capacity has been near or below 2 million b/d since 2002. That’s barely enough to cover the loss of supply from politically shaky exporters like Venezuela and Nigeria. The market becomes very reactive to hints of supply problems when idle production capacity is this low and when its other cushion, oil in storage, is thin.
Inventories growing
Now, however, inventories are growing along with spare production capacity. IEA said total oil inventories held in members of the Organization for Economic Cooperation and Development, representing industrial countries, exceeded the recent 5-year average in July for the first time since April. OECD inventories represented 54.5 days of projected demand, almost 1 day more than the 5-year average.
While demand growth eases, supply expands, and market cushions rebuild, two extra forces thought to have added to price strength earlier this year have subsided: dollar weakness and unusually strong flows of investment capital into commodities. So the forces pushing down oil prices are, for now, very strong. They’re probably even stronger than a hurricane.