World oil markets face a serious oil supply shortfall in the fourth quarter if the Middle East crisis is not resolved soon.
There are ample supplies of strategic stocks to accommodate world demand for oil in the near term. That was an immediate concern in the aftermath of Iraq's blitzkrieg invasion and takeover of Kuwait (OGJ, Aug. 13, p. 17).
However, the loss of oil exports from Kuwait and Iraq will mean a shortfall in the Organization of Petroleum Exporting Countries' ability to meet demand projected in the fourth quarter, even if available spare capacity within OPEC is put to use.
Especially troubling are reports that OPEC remains in disarray over whether to hike production to meet the shortfall of Iraqi and Kuwaiti oil exports caused by a United Nations embargo.
Reluctance among several OPEC members to make up the near term shortfall and thus perhaps violate last month's production and price accord could force a stock drawdown in consuming nations before the fourth quarter, when oil demand is expected to rise.
Even with a stock drawdown helping, the likelihood that contingency stocks will be retained during the crisis could mean a stock draw unable to make up the shortfall.
The specter of supply crisis grows with the increasing prospect of a long Middle East stalemate involving foreign hostages in Kuwait or Iraq or a widening of the conflict. Iraq's peace initiative to western nemesis and price hawk Iran could further either scenario.
In other developments, Kuwait Petroleum Co. (KPC) has rebounded from the crisis by setting up an office in exile in London to keep its extensive European downstream operations running smoothly.
With the crisis, the Persian Gulf tanker business faces another grim period similar to that of the Iran/Iraq war.
Meantime, the two biggest oil users, Japan and the U.S., are reacting in widely different ways to the crisis. (For U.S. government action, see Watching Washington, p. 36.)
Industry and some government officials are pressing a fresh initiative to cut U.S. dependence on oil imports by gaining access to federal land on the Outer Continental Shelf and on the Coastal Plain of Alaska's Arctic National Wildlife Refuge.
SHORTFALL LOOMING?
If Iraq and Kuwait production remains shut in for a long time, there is the likelihood of a 2-3 million b/d OPEC oil supply shortfall in the fourth quarter.
The International Energy Agency pegs demand for OPEC oil at 22.3 million b/d in the third quarter and 24.6 million b/d in the fourth, assuming no change in current stock levels.
The projected fourth quarter call on OPEC oil would be well beyond OPEC capacity available with the loss of Kuwait's and Iraq's production.
In July, Iraq produced 3.1 million b/d and Kuwait 1.6 million b/d. Combined internal demand for the two countries was 400,000-450,000 b/d. The loss of supply to the international market is about 4.2 million b/d.
The Central Intelligence Agency estimates Iraq and Kuwait's combined productive capacity at 5.7 million b/d.
Subtracting Iraq and Kuwait available capacity from total OPEC available capacity leaves 22.34 million b/d available and 21.74 million b/d sustainable, according to the CIA. There is little spare productive capacity available outside OPEC, so a long embargo of Iraqi and Kuwaiti crude means an oil supply shortage in the fourth quarter if projected demand estimates hold up.
The upshot of that is a likely small stock draw in the fourth quarter, a further spike in oil prices, and plunging demand because of more conservation and slower economic growth, perhaps a recession.
DOE sees the net OPEC shortfall at a little more than 1.45 million b/d if Iran, Saudi Arabia, and Venezuela produce at capacity. That still leaves about 1 million b/d of surplus capacity elsewhere, DOE said. However, even DOE's more conservative estimate depends on these key OPEC producers agreeing to expand production. That is still in question.
OPEC DISARRAY
A statement from Venezuelan President Carlos Andres Perez indicating Saudi Arabia and Venezuela were trying to convene an early OPEC meeting to discuss market stabilization measures produced more wrath from Iraq.
The Iraqi ambassador in Venezuela said any increase in production beyond agreed OPEC quotas to compensate for lost exports from Iraq would be considered an act of aggression against Iraq.
"Anyone who takes any action against us will end up injured," he warned.
Indonesia's Oil Minister Ginanjar Kartasasmita said in Jakarta the high level of stocks in the industrial countries should be drawn down before OPEC agrees to an increase in production.
"If stocks are substantially less, OPEC would meet in early September to discuss ways to stabilize the market," he said. "As long as we do not see proof of oil stock cuts, Indonesia is against any meeting or raising production."
Venezuela early in the month backed away from early indications it would hike production to ease the shortfall when Energy and Mines Minister Celestino Armas said Venezuela would not exceed its OPEC quota "and fall to the price race game as a result of developments in the gulf."
The United Arab Emirates, one of the most frequent quotabreakers in the past, called on all OPEC states to strictly adhere to quotas. Ecuador and Nigeria early in the month also vowed to adhere to quotas.
OPEC SIGNALS
Industry sources expect most Persian Gulf countries to take on new customers that are likely to experience short term supply problems because of the lack of Iraqi and Kuwaiti oil.
Venezuela's Foreign Minister Figuerdo Planchart flew into Saudi Arabia for high level talks on the political situation and its implication for crude oil supplies. He then conferred with Iranian officials in Tehran and followed this with a flight to Algiers to meet OPEC Pres. Sadek Boussena.
Venezuela is seen as one of the prime movers of an attempt to boost OPEC production.
Planchart's visit to Tehran coincided with a bitter attack by Iranian President Ali Akbar Hashemi Rafsanjani on countries that might be planning to exceed the production quotas agreed to July 27 (OGJ, Aug. 6, p. 36).
OPEC members taking a unilateral stand on production would be committing treachery against their own people in favor of "the global oil devourers," Rafsanjani said. He also said consuming countries should draw down their stocks before OPEC increases production.
The outbreak of shuttle diplomacy prompted speculation that an emergency meeting of OPEC ministers could be called in an attempt to stabilize production and prices.
But in view of Iraq's belligerence, some sources believe an official OPEC meeting is unlikely. More oil supplies are likely to be made available without publicity, based on diplomatic sounding between members.
OPEC sources say the agreement reached at last month's meeting in Geneva could provide the basis for action on prices and production.
Ministers agreed that if by the next scheduled meeting Dec. 12 the crude price was more than the agreed $21/bbl marker based on a basket of OPEC crudes, the total production ceiling would be raised and an increment added to the reference price.
OPEC sources say this formula of increasing production and price could be used in the short term, particularly since the Geneva conference agreed future quota increases should be distributed among members with spare production capacity.
Iraq has threatened other OPEC members if their production levels are raised. Iraqi Foreign Minister Tareq Aziz said OPEC states should take into consideration their own interests before raising production as they might "pay hard in the future" for any increases.
Industry sources said a supply contract between Saudi Arabia and Kuwait Petroleum International (KPI) could be the first sign that OPEC countries in the Persian Gulf are prepared to increase production to offset some of the losses caused by the embargo.
KPC STATUS
Kuwait's state owned KPC has its administration in exile in the London offices of international affiliate KPI.
Eight of the 10 member KPC board are known to be safe outside Kuwait and will decide future policy for KPI, which has become a significant European refiner/marketer.
Kuwait Oil Tanker Co. (KOTC) also moved its headquarters to London and will operate its fleet from there. KOTC controls 30 crude and products tankers and gas carriers with a combined capacity of 2.5 million dwt.
Under its Q8 brand, KPI has about 24% of the Danish market, 12% in Sweden, 10% in Italy, 7% in Belgium, and a little more than 2% in the U.K. KPI also operates a 100,000 b/d refinery in Naples, a 75,000 b/d refinery in Rotterdam, and a 56,000 b/d refinery in Denmark,
In the short term, KPI will have no problem meeting its supply needs because sizable volumes of crude and products that left Kuwait before the Iraqi invasion are still in transit and will arrive up to the end of September.
KPI estimates it will have access to 15 million bbl of oil from this source, with the added bonus that payment to the parent company in Kuwait will not be immediately demanded.
But anticipating the embargo related shortfall of 400,000 b/d of oil KPI typically receives from Kuwait, KPI is looking for other sources of supply.
To that end, KPI bought two crude oil cargoes and is likely to sign a supply deal with Saudi Arabia that should solve its crude supply problem.
KPI said it has solved operational problems stemming from the decision of many European countries to freeze Kuwaiti assets to prevent them from falling into the hands of the Iraqis.
EMBARGO'S EFFECTS
Saudi authorities prevented Iraq from offloading some of the 10 million bbl of crude in storage tanks at Yanbu terminal of the IPSA-2 pipeline on the Red Sea coast.
The 155,211 dwt Iraqi tanker Alqadisiyah was turned away from the al-Muajiz terminal, forcing the empty vessel to anchor off the terminal.
Storage tanks at the terminal are full, and the pipeline operation has shut down.
The arrival of the Iraqi tanker was the first real test of Saudi Arabia's resolve. Three previous expected loadings from the terminals were canceled when one Norwegian and two Indian tankers obeyed orders from their respective governments to abandon the planned liftings.
Attention now focuses on the Jordanian port of Aqaba. Jordan is not a signatory of the United Nations embargo, and there are reports that goods and equipment bound for Iraq are being imported through the port.
Iraq has considerable experience of running road tanker shuttles to move its crude oil overland. During the 8 year Iran/Iraq war Iraq regularly moved large volumes of oil by trucks through Turkey and Jordan.
The Turkish outlet for crude is closed by Turkish participation in the U.N. embargo, but Iraq still has the facilities to move oil overland through Jordan.
However, there are considerable risks in using Aqaba because the port is less than 5 miles from the Israeli border.
iraq's Mina al-Bakr terminal in the Persian Gulf remains open and has a capacity to load as much as 400,000 b/d.
But since the embargo was imposed, no tankers have attempted to approach the terminal.
TANKER TRADES
The embargo immediately produced a line of tankers off the Indian Ocean coast of Oman waiting for work.
The vessels had steamed to the area expecting to pick up cargoes at the head of the Persian Gulf.
The anchored tankers are reminders of the situation in the Iran/Iraq war when vessels used this area to prepare for dangerous passage to pick up oil from Iran, Kuwait, and other ports within air strike range of both sides.
On this occasion, the tanker owners show no sign of wanting to test the ability of the growing number of warships in the area to enforce the embargo.
A smaller fleet of anchored vessels is forming off the Turkish port of Ceyhan, the tanker export point for the closed Iraqi pipeline through Turkey.
London shipbroker E.A. Gibson said tanker owners again face the prospect of profitless operations. The tanker industry will again have to endure a traumatic period of readjustment to adapt to reduced oil production levels, soaring bunker costs, and rising insurance premiums, he said.
The most worrisome tanker trend is a decline in the level of business from the Persian Gulf.
In the first 2 weeks of any summer month the tanker industry would expect to obtain as much as 5 million metric tons of oil. However, in the first 2 weeks of August, the volume has fallen to about 1.25 million tons.
The tanker industry expects to pick up business from other OPEC members who move to fill the supply gap that's left by Iraq and Kuwait, but this expectation has not yet translated into charters.
Tanker owners also will have to reposition ships to take advantage of any increase from Nigeria and Venezuela, which are expected to make more crude available.
JAPAN'S RESPONSE
The fact that Japanese companies were the biggest lifters of crude from Iraq was not reflected in Japanese reaction to the crisis.
Japan's government and oil companies are more concerned about the possible effect of higher crude and product prices on inflation than a supply shortage.
This confidence is based on high levels of strategic crude stocks in Japan. After the supply crises of the 1970s, the Japanese government pledged to introduce its own strategic reserves and started stockpiling in 1978 through Japan National Oil Co.
Japanese strategic stocks currently stand at 520 million bbl, Japan's Natural Resources and Energy Agency estimates. That is lower than the IEA's estimate of 565 million bbl.
Stocks break out as 197 million bbl government held and 322 million bbl in private storage. Japan's stocks are equal to 142 days of consumption and compare with stocks of only 50 days' consumption in the mid-1970s.
During the 1979 supply crisis private Japanese stocks were drawn down, but government reserves were untouched.
Private companies have permission from the government to lower stock levels to 82 days from the current 88 days to meet higher demand in September. Petroleum Association of Japan said companies needed at least 45 days' stocks to keep the domestic refining/marketing network functioning efficiently.
The government is expected to start releasing oil from its reserves if private stocks start to fall toward minimum levels. But an association official said the government could take action sooner as part of an agreement among major industrial powers to use reserves to rein any surge in oil prices.
Meantime, Japan's government has taken early action to prevent two LPG carriers under construction for KOTC by Mitsubishi Heavy Industries from being delivered. The work is just getting started, and the vessels are not due to be delivered until first half 1992. The action shows the Japanese government is prepared to take a tough line on economic sanctions even at this early stage.
KOTC also has ordered two 280,000 dwt tankers from the Daewoo and Hyundai yards in South Korea. Work is continuing, and the South Korean government has a less positive attitude to blocking this aspect of trade with the embargoed countries.
JAPAN HARDEST HIT
Japan has been hardest hit by the embargo.
Japanese companies had been lifting about 220,000 b/d from Iraq and had contracts for about 150,000 b/d from Kuwait.
In attempts to make up the shortfall, most of the affected Japanese companies have sent crude buyers to Tehran. Japanese companies had reduced liftings of Iranian crude for the third quarter but apparently have found no problem in buying additional volumes.
At the first of the year Iran was exporting 290,000300,000 b/d of crude to Japan, but this has fallen to 230,000 b/d this quarter.
Iran told Japanese buyers an additional 60,000-70,000 b/d can be made available immediately for lifting in August. In addition, there are reports that Iran is prepared to supply another 300,000 b/d in September. in the fourth quarter Japanese liftings from Iran could rise to 700,000 b/d.
National Iranian Oil Co. (NIOC) said the increased liftings to Japan can be accommodated without exceeding its OPEC quota of 3.14 million b/d by diverting exports currently going to western Europe or North America. In July, Iran's production was only about 2.8 million b/d.
PRICE FORMULAS
Having agreed on volumes for the rest of the quarter, the Japanese teams are now talking prices with NIOC.
Both sides have noted new price formulas imposed by the Saudis for Aramco exports to the Far East, U.S., and Europe.
The new Saudi price will go into effect for September deliveries. The price of Arab light for delivery to the U.S. will be based on the Alaskan North Slope spot price with a discount of $1.10/bbl. Previously the discount had been $1.85. The discount on Arabian medium will be $2.45 vs. the previous $3.20, Arab heavy $3.80 vs. $4.55, and Berri extra light 20 vs. 95.
The Saudi price for deliveries to Europe is discounted against the Brent spot as follows: Arab light $2 vs, the previous $2.75, Arab medium $3.35 vs. $4.10, Arab heavy $3.80 vs. $4.55, and Berri extra light $1.10 vs. $1.85.
For Far East deliveries the Saudi price is based on a discount or premium to the average of Oman and Dubai spot prices as follows: Arab light premium of 35-up from parity, Arab medium $1 discount vs. $1.35, Arab heavy $1.45 discount vs. $1.80, Berri extra light premium of $1.25 vs. 90.
Iran has been forced to cut its formula for Far East prices twice this year in the face of declining market interest and is trying to restore its relative market share.
NIOC has been seeking a premium of 75/bbl over the spot price for Omani crude for Iranian light, compared with a previous discount of 25. For Iranian heavy it wants a discount of 15 against Dubai crude vs. the previous discount of $1.15.
U.S. OCS OPTION
Sen. Bennett Johnston (D-La.), chairman of the Senate energy committee, wrote President Bush Aug. 8, urging him to reconsider moratoriums on OCS leasing and development.
"The combined effect of your decision, as announced June 26, was to place off limits to oil and gas development until after 2000 more than 99% of the California coast, the coast of Southwest Florida, the Georges Bank area of the North Atlantic, and the coasts of Washington and Oregon.
"Given the crisis in the Middle East, and at a time when nearly 50% of the oil we consume is imported, I question the wisdom of banning development of these substantial domestic reserves. Nearly a quarter of U.S. estimated oil reserves and well over a quarter of U.S. estimated gas reserves are on the OCS."
Johnston said Bush had qualified the leasing deferrals, saying that external events such as supply disruptions might require a reevaluation of the moratoriums.
"I believe the embargo on Iraqi and Kuwaiti oil and unfolding events in the Middle East warrant reconsideration of your previous decision in view of national security concerns," Johnston wrote.
"The crisis in the Middle East points out our vulnerability as a nation when the cornerstone of our energy policy is-as it has been-the importation of foreign oil. I strenuously urge you to redirect our national energy policy to emphasize domestic production and, as a first step toward this goal, to reconsider your decision on the OCS moratoriums."
Speaking at an Alaska meeting, Barry Williamson, Minerals Management Service director, said the Bush administration has no immediate plans to change that policy.
ANWR OPTION
Alaska's senators plan to press a bill allowing exploration on the highly promising ANWR Coastal Plain when the Senate reconvenes in September.
The Senate energy committee reported out an ANWR bill in the last Congress, but efforts to hammer out legislation were shelved after the Exxon Valdez oil spill.
Sen. Ted Stevens (R-Alas.) said the U.S. needs more oil reserves to maintain national security.
He said, "It is an absolute fact that Alaska is supplying more oil to the U.S. than Saudi Arabia, but Prudhoe Bay field is being overproduced. We expect a 20% decline in production in the next 5 years and a 30% decline in the 5 years following. By the end of this decade, production will drop from last year's 2.1 million b/d to 500,000 b/d."
"The only way to keep the throughput of the Alaska pipeline up to where it maintains the economic security of the U.S. is to gain access to the areas of the Arctic where access is now denied so our industry may start the process of exploration.
"If we authorized the exploration of ANWR this year, we would see oil exploration starting in 1991 and, assuming discovery, we could have oil from the ANWR area into the Alaska pipeline by 1994. If that is not done, the U.S. will increase its demand for foreign oil, increasing our reliance upon the Middle East at the rate of about 200,000-300,000 b/d each year."
In debate on the National Defense Authorization Act, which the Senate passed Aug. 4, senators accepted an amendment by Sen. Frank Murkowski (R-Alaska) requiring the administration to act to reduce oil imports.
The amendment requires that whenever oil imports are expected to exceed 50% of U.S. consumption, the administration must draft a plan to lower them.
The plan would list onshore and offshore federal land that would be offered for leasing, energy conservation actions, and production incentives for domestic oil and gas.
In the latter, the government would have to consider imposing an oil import fees, royalty reductions, and tax incentives for domestic production.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.
