CRUDE PRICE SLUMP TEMPERS MIDYEAR OUTLOOK

Robert J. Beck
Economics Editor

The rollercoaster ride for world crude prices that started in 1986 is continuing through 1990.

Once again, excess production by members of the Organization of Petroleum Exporting Countries has created a sharp drop in crude prices. The drop, however, hasn't been as severe as in past cycles.

Exploration and production activity in the U.S. and elsewhere is up from a year ago.

Increased demand has boosted expectations for tight oil and natural gas supplies and higher prices. This has spurred drilling activity, particularly in the U.S., where the rig count for the first half of 1990 averaged 22% above 1989.

Even though demand has been moving up, there is still excess production capacity worldwide, and crude prices remain at the mercy of OPEC. The group set a production quota of 22.086 million b/d starting in 1990. Through the first 5 months of the year, however, its output averaged an estimated 23.6 million b/d.

Much crude flowed into storage during the first half. The inflated stock levels may put more downward pressure on prices throughout the year.

In the U.S., average demand is down slightly from a year ago but remains fairly strong. This has enabled refiners to maintain product prices at levels close to a year earlier, even though crude prices are down, and to boost refining margins.

For the year, U.S. demand for petroleum products will be down slightly from a year ago due to unseasonal weather and slower economic growth.

But the decline will be marginal and does not reflect any new wave of conservation or fuel switching.

Crude oil production will fall far more than demand, increasing the need for foreign oil. Total imports are expected to reach the second highest level on record in 1990. Import dependency will set a record.

Here are highlights of Oil & Gas Journal's forecast for 1990 and a midyear review of activity in the industry.

U.S. demand for petroleum products will slip 0.2% from last year's level. This is a change from the 1.1% increase forecast at the beginning of the year (OGJ, Jan. 29, p. 49).
U.S. crude and condensate production will drop 5.2%. In January, OGJ predicted a 3.6% decline. A key reason for the change is maintenance on the Alaskan pipeline and pumping facilities, which will further reduce the state's production. Lower 48 output will continue to slide due in part to the low level of drilling.
Total imports will rise 6.8%, not just to make up for falling U.S. production but also to replenish product stocks, which fell in 1988 and 1989. Dependency on imported crude and products will reach an all-time high of 49.5%.
U.S. refinery runs will rise 0.5%, and the refinery utilization rate will move up to 87.3%.
Crude oil prices will average 5% less than 1989. Excess OPEC output will offset worldwide demand gains.
Total industry stocks will rise 3.9%. Product stocks were close to minimum operating levels at the end of 1989 and needed to be boosted. And low crude oil prices encouraged refiners to add to crude stocks.

THE OUTLOOK

U.S. economic growth will be slower in 1990 than in the past few years, which will slow the growth in petroleum product demand.

However, demand slippage this year will mainly reflect unseasonably warm weather early in the year following the unusual cold snap at the end of 1989.

OGJ predicts average demand for all petroleum products this year at 17.29 million b/d, compared with 17.325 million b/d in 1989. First half 1990 demand is estimated at 16.84 million b/d, down 2.7% from 1989's first half. Second half demand will average 17.74 million b/d.

Total demand, including exports of crude and products, will fall 0.4% to 18.12 million b/d for the year. Exports are expected to fall 3.4% to 830,000 b/d.

Among the major product groups, demand will decline for distillates, residual fuel oil, and LPG and ethane. A large part of the decrease results from the warm weather in the first half. Increases are forecast in demand for jet fuel, motor gasoline, and other products.

Motor gasoline demand will rise on the strength of increased driving and a larger vehicle fleet, which will more than offset the continued increase in vehicle fuel efficiency.

U.S. crude oil and condensate production will average 7.22 million b/d this year. Although drilling activity is up from a year ago, it is not sufficient to stem the slide in Lower 48 production. Total output will be the lowest since 1961.

Total petroleum imports will average 8.55 million b/d, 49.5% of U.S. demand.

Crude and product stocks will rise in 1990. Refiners will increase runs to rebuild product inventories even though demand will slip.

Product stocks dipped too close to minimum operating levels in 1989, and refiners are boosting them to provide some contingency supply and avoid any temporary emergency or weather related shortages.

The increase in product stocks will help boost refinery runs this year even though demand will slip. Crude runs will gain 0.6%, and refining capacity will sink by the same amount. The result will be an increase in the capacity utilization rate to 87.3%.

Although crude prices will fall, continued strong demand will boost prices slightly for some products.

PRICES SHAKY

OPEC's persistent overproduction this year contrasts with last year's relative restraint.

Prices fell throughout this year's first half. The average world export price dropped from an average of $19.27/bbl in January to $13.51/bbl in June. Last year prices moved up from $15.04/bbl in January to $18.24/bbl in April.

This year's first half average crude price-$16.36/bbl -was only 1% lower than last year's average for the same period, when prices were moving in the opposite direction. This year's June average, $13.51/bbl, was down 18.3% from a year earlier.

OPEC this summer will receive some help from maintenance projects scheduled in Alaska and the North Sea, which will reduce worldwide production. Therefore, it is doubtful that crude prices will collapse. More likely, prices will remain close to the depressed June level until demand starts picking up at the end of the third quarter. The export price will average about $15.80/bbl for the year, down 5% from 1989.

The U.S. wellhead price of crude oil averaged $17.76/bbl for the first quarter this year vs. $14.55/bbl last year. These are the latest official figures available. The price dropped to an estimated $15.47/bbl for April, compared with $17.01/bbl the year before.

The U.S. wellhead price closely tracks the world export price. OGJ projects an average U.S. wellhead price of $15/bbl for 1990, down 5.4% from 1989.

U.S. product prices have not shown the weakness exhibited by crude prices. Strong demand for many products has enabled refiners to maintain prices even though feedstock costs have been falling.

The OGJ survey of self-service unleaded motor gasoline pump prices shows the average for the first half of 1990 at $1.0455/gal, up from $1.006/gal last year. The price at the end of June was $1.0512/gal vs. $1.0702/gal a year earlier.

The first half gasoline price gain of 3.9% contrasts with the slight decline in first half average crude prices. The 1.8% June price dip contrasts with the 18% crude June-to-June price drop.

Gasoline taxes for the first half of 1990 rose to 25.02/gal from 24.16/gal in the same period last year.

Gasoline taxes are expected to move up through the year. California boosted its state gasoline tax 5/gal July 1. Other states may follow.

OGJ projects the pump price for all types of motor gasoline, including premium grades, to average $1.107/gal for 1990, up 4.4% from $1.06/gal for 1989. The overall price average peaked in 1981 at $1.353/gal.

Residential heating oil prices for the first 3 months of 1990 averaged $1.017/gal, up 18.4% from the first quarter last year. The sharp increase was associated with the extremely cold weather in December 1989, which depleted stocks and increased secondary stock demand for fuel oil for the first couple of months of the 1990 winter season. OGJ expects heating oil prices to average 940/gal for the year, up 4.4% from last year.

U.S. consumption of natural gas is expected to slip 1.1% to 18.75 tcf this year. Gas prices will remain close to their levels of the last 2 years,

OGJ expects the U.S. wellhead price for natural gas to average $1.70/Mcf in 1990, compared with $1.71/Mcf last year and $1.69/Mcf in 1988.

Gas prices peaked in 1984 at $2.66/Mcf. They fell to $1.67/Mcf in 1987 as demand weakened. Despite the fairly constant average since then, there have been sharp seasonal swings related to demand.

Gas consumption totaled 17.951 tcf in 1984. It fell to 16.221 tcf in 1986 but rebounded to 18.956 tcf last year.

ENERGY DEMAND TRENDS

The U.S. economy is in its 8th year of continuous economic growth, a record. OGJ expects real gross national product (GNP) to increase 1.86% in 1990, the slowest growth rate of the expansion period.

Last year's growth rate was 2.98%. Growth has averaged 3.6%/year since 1982.

Energy consumption, which declined in the early 1980s, moved up 15.3% during the 8 year expansion-an average rate of increase of 1.8%/year.

Consumption has increased more rapidly in recent years because of relatively low energy prices and growth in energy intensive industries. In the past 4 years GNP increased 13.5%, energy consumption 10%.

This year energy conservation and efficiency will increase to a degree. Energy consumption will rise only 0.6% to 81.69 quadrillion BTU (quads), while GNP increases 1.86%.

Energy consumption per unit of GNP has been falling since 1970, dropping from 27,800 BTU in 1970 to 19,600 BTU in 1989. OGJ projections show further improvement in 1990 to only 19,400 BTU/$ of GNP.

Oil energy demand is expected to slip 0.2% in 1990 to 33.94 quads. Oil's share of total energy demand will also fall, dropping to 41.6% from 41.9% last year and 42.7% in 1988.

Demand for energy from natural gas will drop 1.1% to 19.3 quads. This follows a 5.1% increase last year. The gas market share will be 23.6% vs. 24% in 1989 and 23.1% in 1988.

Energy from coal will continue to climb on the strength of increased electricity demand. Coal consumption will move up 1% to 19.11 quads. The coal market share will increase to 23.4% from 23.3% last year.

Hydroelectric and geothermal energy output will move up 8.8% in 1990 to 3.38 quads. The market share will move up to 4.1% from 3.8%. Hydro power output has been well below capacity the last couple of years because of drought in the western U.S.

Nuclear energy output will increase 4.8% this year to 5.96 quads, representing 7.3% of the market. Nuclear power output increased only 0.5% in 1989. The growth in nuclear power is expected to be slow in future years as few new units will be added.

The slowing of growth in nuclear power means the electric power industry will have to turn to other fuel sources in the future, probably coal and natural gas.

PRODUCT DEMAND SLUMPS

The first half product demand slump generally reflects warm weather and price increases. The demand decline for LPG and ethane stem from the weather and petrochemical industry slowdown.

Motor gasoline demand slipped 1.1% during the first half to 7.19 million b/d. Gasoline prices averaged 3.9% higher than in first half 1989. Sluggish economic growth also played a part.

Distillate fuel oil demand was down 2.7% from a year ago at 3.095 million b/d. Prices jumped during the cold spell in December last year and carried over into the 1990 portion of the heating season.

Demand for residual fuel oil dropped 10.4% from the first half of 1989, averaging 1.29 million b/d this year.

Starting the year, resid prices were 42% above the price at the start of 1989. Resid demand is quite sensitive to price swings since it is often in direct competition with natural gas and coal. During the first 2 months of this year consumption by electric utilities was down 34% from a year earlier.

OGJ projects a product demand turnaround in the second half, reflecting stable and relatively low product prices and some economic growth. High prices suppressed demand at the start of the year. But lower crude prices and substantial inventories will prevent any major rise in prices during the second half.

Second half demand, therefore, is expected to be up 2.3% from a year ago, averaging 17.74 million b/d, which will offset most of the first half slump.

Demand for petroleum products has recovered in recent years. Demand hit an all time high of 18.847 million b/d in 1978 and slipped to 15.231 million b/d in 1983 before starting back up.

The recovery has slowed the last couple of years. The projection for all of 1990 is about the same as the 17.283 million b/d in 1988.

Motor gasoline demand will average 7.335 million b/d this year, up 0.1% from 1989. The rate of improvement in vehicle fuel efficiency has slowed in recent years. Gasoline prices have not changed a great deal from a year ago and are well below peak prices of the early 1980s.

Gasoline demand has remained relatively constant the last 3 years. Demand in 1988 averaged 7.336 million b/d. Motor gasoline demand peaked in 1978 at 7.412 million b/d.

Distillate demand will average 3.13 million b/d this year, down 0.9%. Demand for highway diesel will continue to move up in 1990, but the increase won't be large enough to offset the decline in residential and commercial consumption of heating fuel oil. In addition to this year's warm weather, demand has been hurt by conversions to natural gas and increased heating unit efficiency.

Lower prices during the second half of the year are expected to help sustain demand for residual fuel oil at levels close to those of a year ago. However, due to the weak first half average, demand for the year will be down 3.7% at 1.32 million b/d. This mainly reflects the drop in consumption by electric utilities, which switch away from heavy fuel oil to natural gas or other fuels when the oil price gets too high.

In January 1989 the cost of heavy fuel oil delivered to steam-electric utility plants was only 3.8% higher than natural gas on a BTU basis. In January this year it was 37.4% higher than natural gas.

Demand for LPG and ethane is projected to average 1.61 million b/d in 1990, down 3.5% from the year before. Demand was lower in the first half of this year due to weaker petrochemical feedstock demand and the warm weather.

Demand for all of the other petroleum products is expected to move up 2.9% in 1990 to 2.38 million b/d. Included in this category are petrochemical feedstocks, special naphthas, lubricants, waxes, petroleum coke, asphalt and road oil, still gas, and miscellaneous products. Demand for asphalt and road oil will lead the gains.

GAS DEMAND DIPS

The 1.1% decrease projected for natural gas demand this year follows increases of 4.7% in 1988 and 5.1% in 1989.

The industrial sector accounted for 50.8% of the 1.745 tcf gas demand increase of the past 2 years. But demand also moved up in the residential and commercial sectors.

This year's comparative weakness will result mainly from the early warm weather and competition from low cost fuel oil. Gas also will receive increased competition in the power market from nuclear and hydroelectric gains.

Marketed production of natural gas will increase 1.2% this year to 18.16 tcf. The gain will come despite lower demand due to the need to replenish storage drawn down last December.

Imports of natural gas are expected to increase 12.5% in 1990 to 1.55 tcf. Imports from Canada will move up 12.3% to 1.5 tcf. There will also be a small but steady supply of LNG from Algeria, growing to 50 bcf in 1990 from 42 bcf last year.

THE PRODUCTION SLIDE

The decline in U.S. crude and condensate production will continue beyond 1990.

It started in early 1986 and has accelerated recently. Last year Alaskan production was hurt by the Exxon Valdez oil spill in March. This summer's pipeline and pump station maintenance projects will reduce Alaskan flow for several months.

U.S. production during the first half of 1990 averaged an estimated 7.315 million b/d, down 5.6% from the first half a year ago. Alaskan production dipped to 1.781 million b/d in the first half this year from 1.888 million b/d in the first half of 1989 and 2.031 million b/d in the same period of 1988.

Lower 48 production also dropped during the first half-5.6% to 5.534 million b/d.

Production is expected to continue to fall in the second half, averaging 7.125 million b/d. Alaskan output will average 1.75 million b/d, that of the Lower 48, 5.375 million b/d.

Alaskan production will bounce up after the maintenance projects are completed to average 1.81 million b/d in the fourth quarter. Lower 48 production will continue its slide to 5.33 million b/d.

For the year U.S. production will average 7.22 million b/d, down from 7.613 million b/d last year and 8.14 million b/d in 1988.

U.S. production reached a recent peak of 8.971 million b/d in 1985 and averaged 9.108 million b/d during the first quarter of 1986. Production had been pushed up in the early 1980s by high rates of drilling and increased North Slope output. The drilling decline since 1986 and the recent start of the North Slope's decline hurt production now.

Alaskan output is expected to average 1.765 million b/d this year vs. 1.874 million b/d in 1989. The peak was 2.017 million b/d in 1988. Lower 48 output will dip to 5.455 million b/d from 5.739 million b/d last year.

IMPORTS CLIMB

U.S. imports continue to climb, filling the gap between falling domestic output and rising demand.

Total imports, excluding crude for the Strategic Petroleum Reserve (SPR), averaged 8.455 million b/d during the first half, up 7.6% from first half 1989. Imports will average 8.645 million b/d in the second half. The year's expected 6.8% import gain follows an 8.8% jump in 1989.

The expected 8.55 million b/d import average is surpassed only by the 1977 average of 8.786 million b/d. Industry imports dipped to a recent low of only 4.949 million b/d in 1985 as a result of an increase in domestic production and a decrease in product demand, both related to the sharp run-up in crude prices.

Crude imports, excluding the SPR, are projected to increase 8% in 1990 to 6.25 million b/d quota following a 14.5% gain last year. During the first half this year they averaged 6.17 million b/d, 12% ahead of 1989's first half. Crude imports by the government for the SPR are expected to average 55,000 b/d during 1990, about the same rate as the past 2 years.

Product imports are also expected to be up in 1990-3.7% to 2.3 million b/d. During the first half product imports averaged 2.285 million b/d, down 2.9% from first half last year. Increased demand for residual fuel oil and motor gasoline in the second half are expected to boost product imports. With little excess capacity at U.S. refineries upward movement in product demand could result in increased product imports.

The leading source of crude imports during the first quarter was Saudi Arabia at 1.155 million b/d, up 3.5% from the first quarter of 1989. Crude imports from Saudi Arabia averaged 1.116 million b/d for all of last year. They were as low as 131,000 b/d in 1985.

Total U.S. crude imports from OPEC members averaged 3.71 million b/d for the first quarter, up 9.9% from the same period a year earlier. Crude imports from OPEC jumped 25.2% in 1989 to average 3.376 million b/d for the year. Crude imports from OPEC represented 61.1% of the total crude imports in the first quarter this year. Crude imports from OPEC were only 41 % of the total in 1985, averaging 1.312 million b/d.

First quarter product imports were up 8% at 2.395 million b/d. Venezuela was the leading source at 375,000 b/d, but this was down 0.8% from a year earlier. Product imports from OPEC averaged 883,000 b/d, up 15.6% from first quarter 1989.

STOCKS UP SHARPLY

Stocks of both crude and products have risen sharply in 1990 and are presently well above year ago levels.

At yearend 1989, crude stocks were at 341 million bbl and product stocks at 660 million bbl. At the end of the first half of this year crude stocks had moved up to an estimated 383 million bbl, product stocks to 720 million bbl.

Crude stocks are well above levels carried by refiners the last few years. Lower crude oil prices have encouraged refiners to carry additional inventory to meet the seasonal upswing in demand expected later this year.

Total industry stocks at yearend 1989 represented 57.9 days of supply at 1989 demand levels. Midyear 1990 stocks represented 63.8 days of supply at current demand levels. At yearend stocks are projected at 60.2 days of supply.

SPR crude stocks continue to move up and are expected to reach 600 million bbl by yearend.

WORLDWIDE TRENDS

Every other year since 1986, OPEC has tested the existence of the laws of supply and demand and the free market. Results have been years of crude price collapse alternating with years of relative stability.

OPEC goes through a laborious process of setting crude production quotas that would balance supply and demand in the market and stabilize prices. Some members then proceed to produce above quota, flood the market with crude oil, and force prices down.

OPEC set its 22.086 million b/d quota in January 1990. But OPEC production averaged 23.886 million b/d during the first quarter this year. Preliminary reports indicate production close to this rate through the second quarter, when demand is traditionally below the yearly average.

OPEC has been moving its quota up with demand in recent years. The quota was only 15.8 million b/d in January 1987.

According to the U.S. Energy Information Administration, the average price of world export crude oil was $19.93/bbl the first week of 1990. The average export price for OPEC crude was $19.69/bbl. By the week of June 22 the average world export price was down to $13.09/bbl, the average OPEC export price $12.80/bbl.

The stated OPEC goal was to stabilize prices for a basket of seven world export crudes at $18/bbl. The average price for these seven crudes was $21.32/bbl the first week of 1990. It had fallen to $13.86/bbl by the week of June 22.

The major violator of the quota has been the United Arab Emirates. The U.A.E. quota is 1.095 million b/d, but its first quarter production averaged 2.073 million b/d this year.

In addition, production from the Saudi-Kuwaiti Neutral Zone apparently is not covered by the quota and averaged 391,000 b/d during the first quarter.

THE PRICE OUTLOOK

The downward pressure on prices will probably continue through the third quarter. According to the International Energy Agency (IEA), stocks held by member countries of the Organization for Economic Cooperation and Development are up substantially from the level at the first of the year. Total OECD stocks on land as of April 1 were 3.371 billion bbl, up 54 million bbl from January 1 and up 133 million bbl from Apr. 1, 1989.

Apr. 1 stocks represented 100 days of forward consumption vs. 92 days on Jan. 1. If refiners choose to work off some of these stocks, demand for OPEC oil will be further depressed.

Total non-Communist production was up 8.8% in the first quarter from the same period last year, an increase of 3.745 million b/d to 46.47 million b/d. Most of this was the 3.577 million b/d increase in OPEC production. Non-OPEC, non-Communist production moved up 168,000 b/d to 22.584 million b/d.

Non-OPEC output would have been up more, but increases were partly offset by drops of 324,000 b/d in the U.S. and 101,000 b/d in Canada. Production from Norway increased 178,000 b/d, and U.K. output was up 104,000 b/d.

IEA projects a 1 million b/d increase in non-Communist demand in 1990 to 53.3 million b/d. It expects only a 100,000 b/d increase in non-OPEC supply. Assuming the year's stock build-up averages 100,000 b/d, demand for OPEC crude will average 22.8 million b/d. This is up from the IEA estimate of 21.7 million b/d for OPEC output in 1989 and more than the current OPEC quota.

Second quarter demand for OPEC oil will be the lowest for the year at 20.6 million b/d. Demand for OPEC oil will then move up to 22.1 million b/d in the third quarter and 24.4 million b/d in the fourth quarter.

If demand for OPEC oil approaches IEA expectations, crude prices should begin to strengthen in the third quarter.

Lower output in the U.S. and possibly in Norway could help rescue OPEC and crude prices before then.

Expectations are that barring an economic downturn, the cyclical swing in crude prices should follow a pattern similar to that experienced in 1986 and 1988. Yet to be determined is the length of the downside of the cycle and whether the price trough will be as deep as in the past two cycles.