WORLD OIL PRICES IN JEOPARDY

Just a little less than 1 year after the astonishingly successful allied campaign that drove Iraqi forces from Kuwait, world crude markets face the prospect of a price collapse triggered by severe overproduction.

In the 18 months since Iraqi forces crossed the border into Kuwait, world crude oil prices have been on a roller coaster. In daily trading, they hit a peak of $40/bbl in the immediate aftermath of Iraq's August 1990 invasion, then slumped to $17.50/bbl for North Sea Brent blend late last month.

Unless the Organization of Petroleum Exporting Countries curbs production in the second quarter of this year, crude oil markets expect more drastic declines.

The short term health of prices will determine the atmosphere when OPEC's ministerial monitoring committee (MMC) meets in Geneva Feb. 12 to discuss reintroduction of a production ceiling backed by individual national quotas.

Crude oil markets will be looking for a workable ceiling reached in an atmosphere that gives traders confidence OPEC members will observe their new quotas. That's an exercise in public relations oil exporters have found almost impossible in the past.

Huge price fluctuations of the past 18 months reflect success of the global industry in restoring the 4 million b/d of crude oil lost when Iraq and Kuwait were excluded from the international crude oil trading system.

Now that Kuwait has resumed oil production and exports and Iraq is making a new attempt to soften United Nations terms for resuming exports, much of the increased production that was so valuable during the occupation of Kuwait is surplus to requirements.

The International Energy Agency predicts world crude oil demand will fall by 3 million b/d from first quarter 1992 to 65.1 million b/d during the second quarter, with OPEC members expected to absorb most of the slide.

OPEC's second quarter forecast is less pessimistic than IEA'S, but it still sees a decline of at least 2.2 million b/d. Both organizations have been forced to cut demand estimates for first half 1992 to reflect lower than expected economic growth among members of the Organization for Economic Cooperation and Development.

When Iraq's tanks pushed into Kuwait, combined OPEC production was 23.2 million b/d. By the end of this month OPEC flow will hit a postwar peak of 24.3 million bid.

And if the production free-for-all continues unchecked, OPEC could be producing 25.1 million b/d by the end of the second quarter. The added production will come from a projected 300,000 b/d rise in Kuwaiti flow and 540,000 b/d from Iraq, providing it accepts U.N. terms for resuming exports.

RUSSIAN DECLINE

The supply cushion provided by excess capacity could be needed if the sharp production decline in the Russian commonwealth continues in 1992 at the rates of 1991 (OGJ, Dec. 30, 1991, p. 24).

Average Soviet crude and condensate flow fell by 1.4 million b/d to 10 million b/d and is expected to go lower during 1992. In the first three quarters of last year, Soviet exports to the OECD area averaged a little more than 1.5 million b/d, a decline of 150,000 b/d from the previous year.

Whether Russia and the newly independent commonwealth states can continue to shield export levels from the drastic effects of declining production is still not clear.

Apart from uncertainties over exports from the former Soviet bloc, supplies from other non-OPEC sources appear to be assured. North Sea production has recovered from extended platform shutdowns for safety improvements. North Sea flow averages about 4.2 million b/d and looks set to continue at high levels. The rate of growth among other non-OPEC countries has continued at a modest level.

EMERGENCY REQUEST

Most OPEC members agree on the need for cuts in oil production in second quarter 1992 to head off a collapse in prices.

But the prospect of an emergency meeting to discuss cuts in production during the first quarter ahead of its next scheduled MMC session is receding because of opposition from Saudi Arabia.

Algeria maintains a lingering hope of persuading other members to call an emergency meeting. But Algerian attention has been partly diverted by the victory of Islamic fundamentalists in yearend elections.

Algeria has been pressing for OPEC first quarter production not to exceed 23 million b/d, reflecting world demand. And if Iraqi production is restored in the first quarter, Algeria wants other OPEC members to cut another 1 million b/d from production.

Another factor militating against an emergency, meeting is doubts over the role of OPEC's president, Nigerian Oil Minister Jibril Aminu. In normal circumstances, he would be expected to play a key part in diplomatic maneuvering behind the summoning of a special conference.

Early this year, Nigerian President Ibrahim Babangida dissolved the cabinet as part of the process of reducing the number of ministries to 16 from 25.

Although oil and energy will survive the reorganization, it is by no means certain that Aminu will still be in office after the reshuffle of ministers that will accompany the changes.

The delicate political situation in Lagos has forced Aminu to cancel a tour of OPEC members in the Persian Gulf. It was to have started Jan. 3 in Saudi Arabia and take him onward to Kuwait, United Arab Emirates, Qatar, and Iran.

The Feb. 12 MMC meeting could turn out to be one of the mammoth sessions that marked OPEC ministerial deliberations in the mid-1980s.

The communique issued after the last ministerial meeting in Vienna at the end of last November gave the MMC the task of deciding a production ceiling for second quarter 1992.

Setting a production ceiling implies a return to individual quotas. When the 13 members start talking quotas, meetings run into weeks rather than days.

After the invasion of Kuwait, OPEC removed the quotas that had loosely guided production levels in the second half of the 1980s. The move, designed to promote a swift buildup of export capacity, was highly successful. It led to rapid replacement of the lost exports from Iraq and Kuwait.

With the exception of Iraq, all OPEC members are taking advantage of the lack of individual production ceilings to produce almost flat out, although there is still a nominal group production limit of 23.65 million b/d agreed for fourth quarter 1991 at the ministerial meeting last September.

QUOTA METHODOLOGY

The real problem in setting quotas will stem from investments OPEC members have made to increase production since the invasion of Kuwait.

IEA figures show OPEC production in fourth quarter 1991 averaged more than 24 million b/d. OPEC sources say total capacity could rise to almost 24.4 million b/d during first half 1992.

Those figures assume Saudi Arabia will maintain production at 8.5 million b/d, Iraq will produce only 400,000 b/d for domestic consumption, and Kuwait will continue to increase its production from 500,000 b/d in fourth quarter 1991 to 700,000 b/d in first quarter 1992. Nigeria and Venezuela also are expected to make small increases in sustainable capacity early this year.

Having invested in restoring capacity, OPEC members will want to extract the largest possible quota. Experience has shown this is a time consuming, often acrimonious business.

Ministers also will have to decide whether only a quick fix is needed to get OPEC through troubled times in the second quarter or whether the method for allocating quotas will form the basis to control production in the longer term.

A significant group of OPEC members, including Algeria and Iran, wants to return to quotas that led to the 22.491 million b/d ceiling established at the July 1990 ministerial meeting that ended just a few days before the invasion of Kuwait.

This would place almost all the responsibility for cutting production on Saudi Arabia, U.A.E., and Venezuela--countries that made the biggest contributions to replacing exports lost in Kuwait and Iraq.

Saudi Arabia and other Persian Gulf countries, possibly with the support of Venezuela, favor proportional cuts in production based on current production.

If Iraq and the U.N. cannot agree on resuming exports, the task of setting quotas will be easier. But if Iraqi oil exports start to flow soon, OPEC could be faced with the requirement to cut about 2 million b/d of production.

The MMC also is likely to take a look at the sharp decline in revenues during the past 12 months,

The July 1990 OPEC meeting voiced hope that the 22.491 million b/d production ceiling would boost the minimum price for a basket of OPEC crudes to $21/bbl from $18/bbl.

Latest figures issued by the OPEC secretariat show that apart from 1990 when members reaped the benefit of the immediate surge in prices after the invasion, prices have failed to approach the target.

In 1991, the average spot price for OPEC's basket of seven crudes was $18.65/bbl, compared with $22.26/bbl in 1990 and only $17.31/bbl in 1989.

IRAQI SITUATION

The U.N. has begun an investigation into why Iraq has failed to accept the Security Council's conditions for resuming crude oil exports. The first of a series of meetings between U.N. and Iraqi representatives was held in Vienna. More meetings are likely early this year.

Iraq's refusal to export oil on terms laid down by resolutions from the Security Council has unsettled U.N. officials who want to see revenues raised for humanitarian purchases of food and medicine and the first contribution to a Kuwaiti reparation fund.

The U.N. has approved the sale of $1.6 billion worth of Iraqi crude during a 6 month period through the pipeline from Iraq's northern fields to the Turkish Mediterranean port of Ceyhan.

Middle East sources say Iraqi is using the contacts with U.N. officials to press for larger volumes of crude sales, the right to export through the export terminal at Mina al-Bakr at the head of the Persian Gulf, and more relaxed sales terms.

In addition, Iraq is making the case for a relaxation of trade sanctions and extra oil exports to permit and finance the import of spare parts to repair production facilities and its oil export terminal.

Iraqi Oil Minister Usamah al-Hiti said oil exports to raise $2.4 billion in revenues are required.

At fourth quarter prices, Iraq would have needed to export about 540,000 b/d during 6 months to reach $1.6 billion in revenues. The Kuwaiti compensation fund would take the first $570 million, leaving the rest for humanitarian purchases. But if the new target of $2.4 billion were approved and the six month sales period remained in tact, exports would rise to 810,000 b/d.

The extent of Iraqi hopes should ensure that the talks last weeks and possibly months.

Even if Iraq can agree with U.N. officials on revised proposals to resume crude oil exports, any deal would need the approval of the Security Council. That is by no means guaranteed.

U.N. officials running the compensation fund could be sympathetic to Iraq's case for boosting exports to raise $2.4 billion following a report to the Security Council by the compensation committee.

If the plan to provide compensation for losses suffered as a result of Iraq's invasion of Kuwait is to be practical, the fund could need a more rapid injection of capital than would accrue from the $1.6 billion ceiling, said the report.

It also pointed out that if revenues were made available to the fund during a longer period, the U.N. could not let Iraq's oil production industry continue to decline.

This is a reference to the widespread cannibalization of production and transportation facilities Iraq has undertaken to maintain production for domestic use and to ensure that oil is available when exports resume.

The report said unless remedial action is taken in Iraq to rehabilitate petroleum installations, the country's oil productive capacity is likely to stagnate at a level significantly below the preinvasion level and eventually decline.

KUWAITI OBJECTIVES

While the volume of oil that could be available from Iraq in the first half of the year remains uncertain, Kuwait has given clear notice of its intentions for 1992.

Kuwait's production is about 500,000 b/d, of which 140,000 b/d goes to meet local demand. Production is due to increase in 50,000 b/d/month volumes to reach about 800,000 b/d in July as new wells are drilled and war damaged facilities are placed back on stream.

Tanker export capacity is scheduled to increase in line with rising export potential. In second half 1992 productive capacity is to rise even faster. By yearend Kuwait should be able to produce about 1.5 million b/d, equal to its July 1990 quota.

Kuwait Oil Co. plans to run detailed reservoir studies at the beginning of next year, when production is to be 1.5-1.7 million b/d, to gather more detailed information on the longer term effects of high volume wells flowing out of control. Industry sources expect this exercise to last for about 6 months.

Depending on results of those studies and the likely demand for OPEC crude in 1993, Kuwait could be back to its preinvasion capacity of about 2 million b/d by third quarter 1993.

Kuwait has told other OPEC members that once sustainable productive capacity his been rebuilt, it expects additional quota to help offset losses to occupation by Iraq.

Kuwait is entitled to a 50-50 split of production from the Neutral Zone with Saudi Arabia. Production from offshore fields operated by Japan's Arabian Oil Co. was quickly restored. It amounts to more than 360,000 b/d.

Onshore facilities operated by Texaco-Getty experienced considerable war damage. Production is expected to resume at about 40,000 b/d next month. Latest indications are that a return to the prewar level of 120,000 b/d will be a long process.

Copyright 1992 Oil & Gas Journal. All Rights Reserved.