OPEC price defense augurs ill for 2003 oil demand

The Organization of Petroleum Exporting Countries is again talking up the $22-28/bbl target price band, and that may prove its undoing in oil markets this year.

The group until recently had temporarily abandoned its fixation on the price band, which in practical terms meant an unofficial target of $25/bbl for an OPEC basket of marker crudes.

That target seems too high, according to Sarah Emerson, managing director of Wakefield, Mass.-based Energy Security Analysis Inc.

"Based on the differentials witnessed in 2000 and 2001, a $25 OPEC basket means $24 Urals, generally $26 Brent, and $27.50 [West Texas Intermediate]—and US gasoline in the low-to-mid $30s this summer," she said. "Statements by OPEC ministers that the target is even higher at the $28 limit of the price band imply even higher prices."

ESAI contends that oil prices at these levels attract "far too much attention," causing consuming country governments "to feel impelled to lean on OPEC members to ease high product prices."

At the same time, Russia's target price for Urals blend crude is less than the $24/bbl the OPEC target would suggest. This could mean Russian producers will feel tempted to step up output, despite Moscow's recent pledge to extend production cuts for the rest of the year (Market Hotline, OGJ Online, Mar. 8, 2002).

"A fairly wide Brent-Urals spread has reinforced the impression… that Russia will not rein in crude exports in the second quarter," ESAI said.

Perhaps the more worrisome concern over OPEC fixating again upon a price band is that the result will be prices too high to sustain a fragile economic recovery. That, in turn, raises for 2003 the specter of the collapsing demand that derailed oil prices last year.

Higher oil prices still ahead

Nevertheless, the recent spike in oil prices—up more than 30% since the first of the year—is not a fluke, contends J. Marshall Adkins, analyst with Raymond James & Associates Inc., St. Petersburg, Fla.

Adkins contends, in fact, that the current economic recovery is a major factor in the recent bull run in oil prices, causing a strong drawdown of stocks. The analyst predicts spot WTI will average $25/bbl this year.

"Since we are expecting US petroleum inventories to fall in the second half of the year, oil prices should move up into the high $20[/bbl] range in the second half of the year," he said.

RJA's oil supply-demand assumptions for the year are:

• Global oil demand growth in 2002 will be up 500,000 b/d (or 0.7%): "Fifteen-year averages suggest that normalized oil demand growth should be two-three times higher than this assumption."
• OPEC compliance with its latest pledged cuts will be about 5%, representing a deterioration from recent levels.
• Non-OPEC supply is expected to be up 500,000 b/d (or 1%), even taking into account Russian noncompliance with its pledged cuts.
• US commercial inventories won't be affected by additions to the Strategic Petroleum Reserve, but "In all likelihood, transferring US commercial inventories to government inventories will not only boost global oil demand by 50 million bbl over the next year, but it will also likely deflate US inventories."

And Adkins thinks these four assumptions likely will prove overly conservative.

Wild cards

So is it too early to declare the market bears in full retreat this year?

Before coming to a conclusion, think about the prospects for market "wild cards" this year.

Growing civil discontent with the regime of President Hugo Chavez in Venezuela could lead to an oil supply disruption in that key source of US oil imports.

The worsening Israeli-Palestinian conflict could revive calls for an Arab (or worse yet, Islamic nation) embargo of oil supplies targeting the US and other Israeli sympathizers. While such an embargo seems a long shot, an extreme escalation in Israeli-Palestinian hostilities coming in tandem with a US-led military action against Iraq lends such a scenario more credibility.

Even if Saddam Hussein were to relent in his opposition to demands for revived United Nations inspections of his capability for weapons of mass destruction, what is the likelihood that the inspections regime will be any different than it was in the 1990s?

The Bush administration's low tolerance for a repeat of such shenanigans—and with it the implicit threat of military action—by itself creats a price-risk premium of a dollar or two, beyond the physical market fundamentals.

Not a good sign for the bears.

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Latest Prices as of Mar. 22, 2002