OIL MARKET PUZZLE HAS MANY PIECES

Oil markets had more to worry about than Nigeria's political crisis last week - a slump in U.S. home sales, for example.

Nigeria's turmoil was unsettling enough by itself. Oil field strikes, having cut production by an estimated 25%, threatened to spread to other industries.

Oil prices zigzagged on each turn of news: up on Monday, when general strikes seemed imminent; down on Tuesday following reports that union leaders had agreed to meet with Gen. Sani Abacha, Nigeria's military ruler. At midweek Abacha acted ready to meet labor demands for release of Mos-hood K.O. Abiola, who won a presidential election last year then went to jail instead of office. But the potential for extended chaos remained great, which placed much of Nigeria's prestrike production of 1.9 million b/d in jeopardy.

THIN CUSHION

That's a lot to lose in a crude oil market that, with Iraq still subject to embargo, has been operating at close to recently expanded capacity. But the market's essential cushion of spare capacity has been thin since the end of the Gulf War, which made many market observers wonder how crude prices could plummet as they did in last year's second half. And if prices could fall in a tight crude market then, what explains their increase since second quarter 1994?

The question has special relevance now that a significant volume of crude supply has fallen under threat. But the threat must be kept in perspective. Existing spare production capacity, thin as it is, can absorb all of the potential loss from Nigeria. Saudi Arabia alone could raise production by 1.9 million b/d if it had to.

So why should crude prices turn jumpy when they acted so oblivious to a capacity squeeze last year? The explanation lies in the product market. Crude prices slumped in 1993 because product values were crashing. But product prices reversed at yearend and climbed through most of the first half of 1994 thanks to rising demand. International Energy Agency sees 1 million b/d more worldwide oil demand for 1994 than it did last December. And it revised its estimate for 1993 demand upward by 400,000 b/d.

The impressive demand surge has its roots in worldwide economic trends: solid expansion in the U.S., recovery elsewhere in the industrialized world, continued growth in Asia. If the trends continue, OPEC by the fourth quarter will be producing more than its current quota of 24.5 million b/d, whether or not it has officially adjusted the group ceiling. And it will be doing so with or without Nigeria. A Nigerian shutdown would advance the date at which OPEC must confront its inevitable quota decision - even if it's a decision to do nothing.

DEMAND QUESTION

Another large question concerns durability of economic growth, especially in the U.S. Federal Reserve Chairman Alan Greenspan, worried about inflation, is raising interest rates. The Clinton administration is threatening a trade war with Japan.

That's what makes last week's report on June sales of new homes in the U.S. - an economic bellwether down 14% from its level a year earlier - important. It may be an early sign of economic slowdown in the country that led the industrialized world out of recession. To oil demand, the significance of foreshortened economic expansion would be at least as great as loss of Nigerian production would be to crude supply.

The market is reminding OPEC and oil companies that changes in crude supply, important as they are, can't explain everything that happens to oil prices. The product side of the market, where demand swings show up first, must never be ignored.