Forecast: price spike; history: price slump

While there may be argument over the size of the "war premium" in current oil prices stemming from the threat of war between the US and Iraq, there is no dispute that it exists. Lurking behind that war premium may be an oil price slump waiting to happen, however.

Th 101968

Will the ghosts of Jakarta hover over the meeting of Organization of Petroleum Exporting Countries oil ministers in Osaka Sept. 19?

Even as US benchmark oil prices continue to hover near $28-30/bbl, some see troubling signs on the horizon that echo the disastrous OPEC meeting in Jakarta in December 1997 that led to a collapse in oil markets.

While there may be argument over the size of the "war premium" in current oil prices stemming from the threat of war between the US and Iraq, there is no dispute that it exists. Lurking behind that war premium may be an oil price slump waiting to happen, however.

Ghosts of Jakarta

The Centre for Global Energy Studies reminds us of the Jakarta OPEC meeting at yearend 1997, when OPEC ministers last agreed to hike production quotas in order to "legitimize" the group's overproduction. That step came amid global economic weakness that signaled the Asian economic crash in 1998.

At the time, OPEC had ignored the signs of slumping demand and jacked up output further, triggering a supply glut that slashed oil prices to less than $10/bbl. Although it had boosted quotas to a point slightly less than the group's actual output of 28 million b/d, the move was tantamount to an invitation to members to produce still more.

The net result was a further increase in actual output of another 1 million b/d in first quarter 1998 just as the recession was gathering momentum and oil demand was tanking along with the global economy.

Jakarta redux?

Now we may have a repeat of that scenario in the offing, according to the London-based think tank. CGES notes that Algeria and Nigeria have been clamoring for increases in their quotas.

With OPEC's overproduction currently running at 1.8 million, the group may be tempted to rescind its January quota cut of 1.5 million b/d while calling on all members to adhere more closely to their quotas. This could accommodate Algeria and Nigeria, which might otherwise decide to ramp up their quotabreaking during the winter.

But if OPEC hikes quotas-even to a point below actual production levels-members might be tempted to repeat their actions following the Jakarta decision in 1997.

"Indeed," warns CGES, "…unless demand growth surges in 4Q02, substantially exceeding the 1.2% assumed in our reference case, OPEC will not have the room to increase output in September if it wishes to keep prices (for the OPEC basket of crudes) at $25/bbl."

Another history lesson

OPEC meanwhile continues to voice support for its target price band of $22-28/bbl (OPEC crude basket), with Sec. Gen. Alvaro Silva insisting Aug. 30 that the group will continue to maintain price stability "during peace or war."

Of course, that comment came in response to queries about high oil prices and US-Iraqi tensions and was intended to underscore OPEC's willingness to step in and alleviate oil supply shortfalls resulting from a US attack on Iraq.

Given the underlying fundamentals of the market today, the group might do well to heed another history lesson, from January 1991: The launch of Desert Storm, intended to oust Iraq from Kuwait, spawned hisory's biggest 1-day plunge in oil prices—buoyed for months at over $30/bbl during the lead-up to the military strike—when it became quickly apparent what a paper tiger Iraq's army was and that there would not be a wider, prolonged conflict in the region.

Opponents of a US strike on Iraq—and they seem to be proliferating daily—warn darkly of a wider conflict, of massive oil supply disruptions and crippling oil price spikes, of the fragility of friendly regimes along the chokepoint that is the Persian Gulf.

In regard to history lessons, maybe it's time to revisit George Santayana.

(Online Aug. 30; author's e-mail: bobw@ogjonline.com)

OGJ Hotline Market Pulse
Latest Prices as of Aug. 30, 2002

NOTE: BECAUSE OF TECHNICAL DIFFICULTIES,
PRICES FROM IPE AND OPEC WERE UNAVAILABLE AT PRESSTIME

Th 101968
Click here to enlarge image

null

Th 101969
Click here to enlarge image

null

Nymex unleaded

Th 101970
Click here to enlarge image

null

Nymex heating oil

Th 101971
Click here to enlarge image

null

IPE gas oil

Th 101972
Click here to enlarge image

null

Nymex natural gas

Th 101973
Click here to enlarge image

null

NOTE: Because of holidays, lack of data availability, or rescheduling of chart publication, prices shown may not always reflect the immediate preceding 5 days.

*Futures price, next month delivery. #Spot price. @New contract

More in Economics & Markets