Oil price fate in hands of Saddam and the weatherman

Well, the fate of oil prices now seems to be in the hands of Saddam Hussein and the weatherman.

Sep 15th, 2000
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Well, the fate of oil prices now seems to be in the hands of Saddam Hussein and the weatherman.

How's that for a comforting thought? That's the best conclusion that can be drawn here, given that OPEC has pretty much done all that it can do to take some of the steam out of oil prices right now.

The 800,000 b/d quota increase affirmed at the outset of this week won't do much to ease high oil prices. To underscore that thought, please note that the NYMEX October contract rocketed up by more than $1.50 afterwards. While there was some subsequent slippage, that was probably due more to profit-taking than anything else. Even assurances by OPEC Pres. Ali Rodriguez that OPEC could produce as much as 2.9 million b/d if need be did nothing to calm market jitters. Oil prices are trading back around $34-35/bbl again. Simply put, the market was demanding at least 1 million b/d, preferably 1.5 million b/d, but OPEC can't accept that such an increment can be sustained without "letting the genie (of overproduction) out of the bottle" again as the seasonally slack second quarter looms into view.

It's not as if a lot of extra OPEC crude on the market will make all that much difference, anyway. The price of crude is being driven as much by tightness in distillate stocks as by any other factor, and putting a lot more crude on the market now won't happen soon enough to make much of a difference in seriously low distillate stocks.

So is OPEC right to avoid dumping a lot more crude on the market right now? Houston analyst Purvin & Gertz seems to think so. In addition to IEA's latest, reduced estimate for fourth quarter oil demand (down 100,000 b/d from its forecast in August), Purvin & Gertz has trimmed its forecast for oil demand growth for 2001 to only 1.2%; it notes that first quarter demand this year was down 0.5% from last year because of higher oil prices. The analyst continues to project oil demand growth of 2% next year, but it warns that, if prices continue at recent trends well in to 2001, demand will weaken further.

Purvin & Gertz contends, however, that the market is, in essence, overhyped:

"Market psychology is a more prominent feature in today's market than we have seen in years," the analyst said. "Prices have oscillated over a $10/bbl range for short periods twice this year already, with little or no perceptible change in real fundamentals."

Purvin & Gertz says its analysis continues to show that there is adequate crude in the market.

"Most of the hype that is agitating the market is simply false. We believe that refiners are only running at levels consistent with their desire to supply the markets with products without building excess stocks.

"Thus, prices are not currently due to an actual shortage of available supply. It will take a more significant move by OPEC to turn market sentiment, at which point prices will probably come down sharply."

Purvin & Gertz disputes what seems to be emerging as a crisis scenario consensus.

"Common claims are that we are looking at a crisis scenario this winter because the refiners do not have enough crude due to tanker shortages and OPEC supply constraints. They also claim that this situation alone, with presumed runs at full capacity, is causing a shortage of product that cannot be regained. Their conclusion is that this is causing high crude prices."

But the analyst contends that crude supply is, in fact, adequate and that this "is confirmed by the fact that the Saudis offered additional barrels but had difficulty moving them due to backwardation.

"The refiners are running only at levels that are consistent with meeting current market demand without building excess inventory buffers that are impossible to protect against devaluation. The root of these market distortions is the OPEC crude market strategy, which has created backwardation.

"One way to reverse the trend is to give the market more than it expects and to force its sales through discounting by assuming the time risk."

But that isn't likely to happen. So the winter looms-and with a return to normal temperatures more likely this year, promises the weather forecasters-at a time when distillate working stocks are going to be at a minimum. So any disruptions in supply will certainly mean steep price spikes-and with it, higher crude prices.

The hype vs. physical fundamentals notwithstanding, Purvin & Gertz concludes that the price of WTI is likely to remain above $30/bbl through the end of winter, then drop sharply.

But there may yet be a crisis scenario on the horizon. Faithful readers of this space will recall speculation here some months ago about the prospect for an "October surprise" from Saddam Hussein, given the likelihood of tight oil markets, strong demand, and a closely fought US presidential election. Such a situation offers an overwhelmingly tempation for Saddam to provoke some mischief in order to make some geopolitical gains. What if, we posited on several occasions, Saddam were to leverage some procedural or political dispute (probably bogus) into a demand for lifting all sanctions accompanied by a threat to halt oil sales for humanitarian aid? That would take 3 million b/d of oil off the market. While various analysts and even OPEC have offered a wide range of OPEC's spare productive capacity, those estimates have ranged from about 1.5 million b/d to 2.9 million b/d. The best estimate is probably to split the difference, because the difference may depend on what rate is sustainable over the long term.

Do the math. If a $35/bbl oil price can be sustained when OPEC offers to boost output only by 800,000 b/d, what do you think the loss of 3 million b/d of supply will do to this market? The fabled-and never before attained-$50/bbl specter may be resurrected, at least briefly.

So what's Saddam up to? Last week, tanker captains loading at Iraq's Mina al Bakr terminal were complaining about Baghdad suddenly slapping them with big, new, and unsanctioned (by the UN) tariffs and the prospect of a boycott of the terminal may be looming.

And only yesterday, reports were coming out of Kuwait that Baghdad was complaining loudly about Kuwait drilling wells tapping oil reserves on Iraq's side of the border and warning darkly of "taking just and proper measures" in response.

Déjà vu, anyone?

OPEC crude oil production, quotas


1. Includes 50% share of Neutral Zone output, estimated at 630,000 b/d in February-April 2000. 2. Iran is not party to the Mar. 27 agreement to increase production effective Apr. 1, 2000 but has announced that it will in fact increase its output to the level quota that would have been allocated. 3. Excluding Iraq. Sources: Middle East Economic Survey, OPEC Secretariat
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Latest Prices as of September 15, 2000

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*Futures price, next month delivery. #Spot price.

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