How will OPEC engineer a 'soft landing' for oil prices in 2000?
How can OPEC engineer a "soft landing" for oil prices in the first half without risking a price collapse? And how much of a market factor will non-OPEC oil supply growth be in the new year?
The new year (yes, I'm one of those purists about the new millennium not starting for another year) begins with a couple of big questions hanging over oil markets this year.
First, how does OPEC-assuming it wants to-engineer a "soft landing for oil prices in the first half without risking a price collapse?
Second, how much of a market factor will non-OPEC oil supply growth be in the new year?
(Of course, the answer to either question is a partial answer to the other.)
London's Centre for Global Energy Studies thinks it has the answers to both questions, addressing them in articles in its latest global oil report.
CGES continues to hammer on its theme that OPEC needs to "take the heat" out of oil prices, noting that the organization has netted an incremental $25 billion in extra revenues because of the oil price increase in 1999 (of course, here, "extra" is a relative term, because it follows a huge collapse in revenues the preceding 18 months).
Nevertheless, the London think tank contends that high oil prices are already beginning to have a negative impact on oil demand growth and are threatening OPEC's longer-term prospects.
"Moreover, constraining its output at a time when there is substantial excess demand for oil makes OPEC increasingly vulnerable to disorderly production boosts by those of its members that might wish to take advantage of the situation," CGES said.
There may already be signs of that; early reports of production cut compliance rates for December have it that OPEC's much-vaunted cohesiveness has taken a hit. The numbers aren't in yet, but markets are already so jittery that a meeting between the energy ministers of Mexico and Venezuela this week pulled oil prices down because the markets perceived that as a prelude to a possible production increase that Venezuela was seeking (as part that country's efforts to boost revenues following the recent horrific mudslides that killed so many thousands). Both ministers hastily denied the rumors (which were counterintuitive, anyway, because a production increase for Venezuela could well result in a new revenue decline if it softened oil prices too much).
But CGES insists that the group must consider a coordinated increase in production this year to avoid crippling demand further. The ticklish question is: How much?
"Before OPEC decides how much more to produce from next April onwards and how to distribute the increase among its members, it needs to agree on a price target to aim for. OPEC has had a totemic price objective of $21/bbl for a long time now, but many believe such a price level is too high over the longer run."
CGES proposes a target that would allow Saudi Arabia to cover its essential payments, and it calculates that at about $18/bbl (dated Brent) in the fourth quarter. It pegs the call on OPEC oil (including maintaining stocks at acceptable levels) should be about 27.7 million b/d for the last three quarters of 2000. So if OPEC were to produce about 7% more, to 28.3 million b/d, from April onward, it would probably achieve that price by the fourth quarter.
CGES suggests the group could distribute this increase not by a conventional pro rata means, which it deems politically unacceptable by excessively rewarding Saudi Arabia and punishing Iran, but to tie the shared increase to March 1999 targets (excluding Iraq): Saudi Arabia topping 8 million b/d again, Kuwait and the UAE more than 2 million b/d, Venezuela near 3 million b/d, and Iran near 3.7 million b/d.
While CGES contends this will leave most members happy, I wonder about the wisdom of a strategy that invokes price targets again. The consultant contends that the main problem is not that OPEC pursues a price strategy but that its price target has consistently been unrealistic. But might not $18/bbl-if for altogether different reasons-also prove unrealistic at some point? There are so many other factors governing oil prices in today's market-many of which are out of OPEC's control, that it might seem unrealistic for any price target to be realistic as a long-term strategy. Is it perhaps time for OPEC just to recognize that such fine-tuning of the market is simply beyond its scope? Should it not just focus on what is within its control-supply-and use that tool in response to what its best guess is regarding demand, plus a perceived reasonable stock level, for a given quarter? And then budgeting conservatively according to reasonable price and revenue projections? Simply getting 11 nations with different agendas to agree on controlling supply is difficult enough; throwing in target prices as well may just be asking for the same kind of trouble that insisting on $21/bbl did.
Whatever the situation is with OPEC managing supply, it is not likely to get much relief from its competitors this year. The longer term holds a different picture, however.
CGES reckons that non-OPEC oil production will increase by a bit over 1 million b/d in 2000, despite the sharp downturn in upstream investment in 1999.
"Although drilling activity is still very depressed and company budgets have been slow to respond to higher oil prices, this year saw a massive increase in non-OPEC production capacity, which should underpin next year's growth as new offshore and onshore fields reach their peak," CGES said. "Without new investment, non-OPEC supply will certainly fall in the longer run as the industry needs to add around 2 million b/d of new production capacity each year simply to stand still. In the short-term, however, the industry is set to reap the benefits of past investments."
CGES notes that the big cuts in upstream capital spending in 1998-99 have accelerated the decline of the most vulnerable fields, especially in the US and North Sea. But, at the same time, the past 18 months have seen more than 40 non-OPEC fields with combined capacity of almost 3 million b/d come on stream, more than enough to overcome to underlying rate of decline in depleting older non-OPEC fields.
"A year ago, the CGES was the first to suggest that there might be no growth in non-OPEC supply in 1999, using a 'top down' approach that tried to take into account the impact of low oil prices on oil field depletion rates and investment plans," CGES said. "For next year, 'bottom up' forecasts may prove to be the better guide, as long as suitably pessimistic assumptions are made about decline rates at aging fields.
For 2000, however, the forecast hinges on production growth from new fields that are already on stream. In fact, the list of new fields slated to go on stream this year is "remarkably short and plays only a small role in the growth in non-OPEC supply expected for the year 2000," the consultant said."
Given the continuing robustness of the global economic recovery and its effect on demand, that sets the stage for either much tighter markets and fairly high oil prices in 2001-or an opportunity for OPEC to preserve demand growth and market share by fine-tuning supply toward that $18/bbl target. Perhaps it will have learned from its actions this year whether or not that is a wise course of action to take.
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