Another oil price spike may be on the way

OPEC's latest action suggests that not only will oil prices be sustained at $25/bbl in the near term but that spikes above $30/bbl are likely again in the second half.

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Another hefty oil price spike is headed this way, judging from an emerging consensus among analysts.

Amid all the entrail-divining going in the wake of OPEC's agreement to cut production again, this time by 1 million b/d, in order to stave off a price slump in the second half, the only disagreement about a price spike is the timing.

Generally, the post-OPEC meeting view of oil markets in 2001 is that a price spike could come in May or June, if US gasoline demand remains strong in the face of higher prices. Or it come in the fall, when refiners must begin rebuilding heating oil stocks.

As mentioned in this space last week, OPEC is micromanaging oil markets by becoming the "just-in-time" swing supplier for the world in order to keep oil prices at a minimum level of $25/bbl. And it's becoming clearer that that level is OPEC's real price, regardless of what its "official" target price band is.

London think tank Centre for Global Energy Studies, in analyzing Saudi Arabia's budget, suggests that one factor in this shift in Saudi policy "may be the kingdom's need for higher prices to meet its spending plans and retire some of the country's soaring debt."

Whatever the Saudis' rationale, CGES contends that OPEC has made a misstep: "Atlantic Basin deliveries will fall as a result of the latest output cut just when refinery demand increases by around 1-1.5 million b/d, as plants come out of turnaround and refiners seek to build product stocks ahead of the summer."

Before that happens, look for a little more price weakness in the second quarter, the analyst says. It noted that eastbound crude liftings are down 2.5 million b/d from last November, while Atlantic Basin demand is seasonally low due to the flurry of refinery turnarounds.

If prices don't rebound as OPEC expects, the group is likely to undertake still a further cut in production. While that would help OPEC sustain $25/bbl in the short term, it would cause prices to spike dramatically later this year, CGES contends.

Economic concerns

All of the projections of oil prices must be considered against the backdrop of the global economy in the short term.

Optimists see a brief dip in the US economy, followed by a swift recovery with limited ripple effects on Asia or Europe. In this case, CGES expects global oil demand to increase by 1.3 million b/d this year.

Pessimists see a longer recession in the US, followed by a slowdown in Asia as that region's expor markets contract. In this case, CGES sees the year's rise in oil demand as less than 1 million b/d.

"A $25/bbl oil price will do nothing to stimulate oil demand growth," CGES said. "If the global economy follows the more-pessimistic path, then OPEC will need to keep cutting output to maintain a price of $25/bbl.

"The longer oil prices remain high, though, the more likely it becomes that the global economy will indeed enter a prolonged period of slowdown.

"OPEC, with its fixation on $25/bbl oil, appears to be intent on undermining the market for its own oil and with it the economies of its members."

Supply-demand concerns

In the short term, it looks as OPEC has done the right thing by cutting production. CGES estimates that a cut in actual production (vs. just the nominal quota reductions) of 700,000 b/d to 27.2 million b/d should yield a dated Brent price of $24.40/bbl in the second quarter-which equates to an OPEC marker basket price within the price band target but a bit short of $25/bbl.

But if OPEC maintains output at 27.2 million b/d over the summer, then dated Brent would climb back up to about $25/bbl.

"However, refiners will be unable to replenish gasoline stocks in advance of the driving season and will have to maximize gasoline production over the summer at the expense of heating oil."

In a repeat of last year's market movements then, Asian and Atlantic Basin refiners at that point would compete fiercely in the fall for crude supplies in order to rebuild heating oil stocks for the coming winter. If OPEC then chooses to boost supply around early October, as it did last year, the market would still be short of oil during this stockbuilding period.

Price forecasts

According to the CGES forecast, that would leave dated Brent averaging $28.70/bbl in the fourth quarter (which implies a repeat of last year's price spikes over $30/bbl) and averaging more than $30/bbl in first quarter 2002.

If OPEC were to instead boost ouptut early in third quarter 2001, however, by 1 million b/d, that would ensure a dated Brent price of $24-25/bbl in the second half. Another hike, of 1 million b/d would be needed at the start of 2002 in order to prolong this "stability" into first quarter 2002, CGES predicts.

If OPEC cuts output again in the face of weakening demand, OPEC will need to make a further big cut in output-perhaps 1.4 million b/d in early May-in order to sustain $25/bbl.

"However, a huge, 4 million b/d output increase would then be required to prevent prices from rising almost uncontrollably in the final quarter of the year."

Iraqi wild card

What the CGES forecast does not take into consideration, however, is what might happen with Iraq.

It's generally not safe to make predictions about what Iraq may or may not do, whether in the context of geopolitics or oil markets. But it seems a safe bet that Saddam Hussein will initiate some sort of mischief as the US undertakes a review of sanctions policy in the next couple of months.

Early indications are that the Bush administration favors an easing of economic sanctions against Iraq-thereby, in theory, easing the pain of Iraqi citizens hurt by the sanctions-but tightening sanctions on Iraq's ability to secure imports of military significance. It has been well-established that Saddam's concern for the well-being of his people would not fill a thimble. But anything that even remotely smacks of interference with his irrepressible desire to extend his hegemony in the future is certain to arouse his hire.

That said, it would hardly be surprising to see an indignant Saddam denouncing the latest shift in US policy on Iraqi sanctions (if "shift" is the right word to use, in light of the aimless drift of the Clinton administration in this regard) as another attack on its soverignty, security, etc. This denunciation is likely to be followed by another suspension of exports. So OPEC-at least those 10 nations bound by quota agreements, thus excluding Iraq-may well find a second cut is not necessary this year. That probably won't change the CGES oil price forecast, but it does add a wrinkle that means even more-volatile oil prices this year.

OGJ Hotline Market Pulse
Latest Prices as of March 30, 2001

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