Everyone in the oil business wants to know when the market will reach bottom. The normal answer would be that the oil market reaches bottom when oil prices quit falling.
Well, prices have quit falling. So why is there this prevailing sense that the market hasn’t yet found bedrock?
The answer: because demand continues to shrink. Next question: So why have prices quit falling? Answer: because the Organization of Petroleum Exporting Countries has cut supply.
For now, price is an unreliable indicator of the market’s health. Any price level dependent on cartel discipline is precarious.
That everyone knows this explains the palpable anxiety of the oil business.
The market will not have reached bottom until demand quits falling. Before then, before the bottom will be in view, the rate of demand decline must diminish.
That hasn’t happened. In its April Oil Market Report, the International Energy Agency projected average 2009 oil demand of 83.4 million b/d—down a whopping 2.4 million b/d from its estimate for 2008.
A month earlier, the agency had put the increment at 1.3 million b/d.
An OPEC rescue?
Before IEA darkened the mood, belief was growing that OPEC had rescued things.
The exporters’ group by December had announced quota cuts totaling 4.2 million b/d against September production. It seemed to be lowering not just quotas but actual output as well.
Crude prices, having fallen below $40/bbl in last year’s fourth quarter, recovered to slightly above $50/bbl.
They were at that level when IEA turned grumpy about demand. Sure enough, the prices of marker crudes slumped back into the 40s.
That they didn’t fall further and in fact bounced quickly back to a plateau around $50/bbl is at least partly due to demand assessments cheerier than IEA’s.
Within days of the 2.4-million-b/d shocker, two less pessimistic forecasts appeared.
Like IEA, OPEC and the US Energy Information Administration publish monthly oil market assessments that update demand projections for the current year.
In its April report, OPEC put 2009 demand at 84.18 million b/d, down 1.37 million b/d from its estimate for 2008. EIA estimated the demand slide at 1.35 million b/d—to an annual average 84.09 million b/d.
The mild price recovery indicates, among other things, that the market took comfort from the two later projections.
So what happens now?
OPEC’s resolve is encouraging. By IEA’s reckoning, the group through March had achieved 83% compliance with its aggressive quota reductions. That’s unprecedented.
The exporters’ group seems to have learned from its calamitous misreading of the market in the late 1990s, when it raised production quotas just as demand was contracting in response to the Asian financial collapse.
Whether the discipline can last is uncertain. Production restraint is uneven, with Saudi Arabia producing below its target and maverick OPEC members like Iran and Venezuela producing substantially above theirs. The kingdom has been known to become impatient with solo sacrifice.
Furthermore, the ability of OPEC producers to cut production is limited by more than revenue needs in relation to the arithmetic of production rates and price. Country needs for associated gas put floors at varying levels below which oil production can’t languish for long.
For now, OPEC seems content with oil prices bobbing in a narrow range around $50/bbl. It will meet at the end of this month to consider next moves.
What OPEC does then will depend greatly on May demand forecasts. IEA will make its new market assessment about the time this column appears. The OPEC and EIA reports will follow.
Those projections will depend on the various agencies’ readings of the global economy, about which news has been mixed.
In April, the International Monetary Fund forecast global economic contraction this year of 1.3%, with no recovery until next year. It earlier expected growth to resume in second-half 2009.
Hopeful sign?
But the Open Market Committee of the US Federal Reserve followed IMF’s pessimism with a report of early signs of, if not recovery, shrinkage in the rate of contraction.
A hopeful sign in the May oil market forecasts would be a lower IEA forecast for demand contraction this year. An ominous sign would be alignment of OPEC, EIA, or both with IEA’s April melancholy view.
All that’s at stake here is health of one of the world’s most important businesses. Who said there’s no drama in economics?
