DEMAND AND PRODUCER POLITICS TO SHAPE SECOND-HALF OIL MARKET

Robert J. Beck
Economics Editor

The oil market will tread a narrow path between economic uncertainty and producer politics in the second half of 1993.

Economies in the U.S., Europe, and Japan remain sluggish, threatening to deny the Organization of Petroleum Exporting Countries the oil demand growth that would help it accommodate resurgent production from Kuwait.

Having rebuilt many of the oil field facilities destroyed by Iraqi troops in 1990-91, Kuwait has declared its intention to produce 2.16 million b/d during the third quarter-400,000 b/d above the quota it refuses to recognize.

With Kuwaiti production back to its levels of before the Persian Gulf crisis, the market no longer needs nearly everything OPEC produces, as it has for most of the past 2 years. The group, therefore, must once again try to apportion production restraint among its members.

In June, OPEC ministers met in Geneva and could agree to nothing better than an extension of the second quarter production ceiling into the third quarter, when demand will be higher.

The low group quota coupled with Kuwait's refusal to accept any quota at all shrouded the entire effort in doubt. It appeared likely after the meeting that some members would ignore their quotas and produce as much as they believed they could sell.

Third quarter demand, therefore, is crucial. If it is sufficiently higher than second quarter consumption, the market may be able to absorb likely OPEC production beyond the 23.6 million b/d group quota.

The world's requirements for OPEC crude are projected at 25 million b/d in the third quarter, rising to 26.4 million b/d in the fourth quarter.

ECONOMIES CRUCIAL

A key to demand through the rest of the year will be economic performances of industrialized countries, most of which are in recession.

The exception is the U.S., the world's biggest oil market, where a modest recovery is under way. There the demand signs are bright.

Although economic growth in the first quarter was marginal, product demand increased significantly, apparently stimulated by stumping prices. That trend probably will continue as international uncertainties about OPEC behavior and worldwide demand keep crude prices low, at least in the third quarter.

A major concern for the U.S. is the accelerating decline of crude oil production. Low drilling activity provides little hope for change.

Exploration and production activity has increased somewhat, however, mostly in response to natural gas prices sharply higher than their depressed levels of first half 1992.

The U.S. rig count hit a record low last year, averaging only 717 active rotaries for the year.

During the first half of 1993, the rig count averaged 684, up 4% from the comparable period a year earlier. During the week of June 25, there were 702 rigs active in the U.S., compared with 645 in the same week of 1992.

Drilling has been sluggish around the world. In May, the international rig count, excluding the U.S. and Canada, was 785, compared with 871 in the same month last year.

U.S. HIGHLIGHTS

Here are highlights of OGJ's 1993 forecast for the U.S.:

• Demand for petroleum products will move up 1.2% from the level in 1992, boosted by economic recovery.

• Demand for motor gasoline will be up 0.6% for the year. During the first half, it was up 0.9% from first half 1992.

• Distillate demand will increase 2.7% from its level a year ago, a result of economic recovery.

• Crude and condensate production will slide 3.1% during the year. First half production was down an estimated 4.4% from its level in 1992. Alaskan production was down 6.7% in the first half, Lower 48 output down 3.6%. The rate of decline is expected to slow during the second half.

• Total imports will increase to fill the gap between increasing demand and falling production, pushing total import dependency to a record high 47.9% of demand. Last year's dependency rate was 46.2%. The previous record was 47.7% in 1977.

• Refinery runs will increase 0.7% for the year due to higher product demand. The refinery utilization rate will rise to 89.8% from 88% in 1992. Operable refining capacity will fall again in 1993, leading to growing dependency on imported products.

• Total industry stocks will be up 3.5% at yearend 1993. Last year, crude and product stocks fell to near minimum operating levels. Crude oil stocks will rise to 340 million bbl.

U.S. DEMAND OVERVIEW

U.S. economic growth is expected to gain momentum in the second half. Increased demand for energy and petroleum products in the first half indicates that the recovery is taking hold, particularly in the industrial sectors.

Even with the marginal economic growth rates reported for the first half, demand for petroleum products moved up 1.7% from the same period a year earlier.

OGJ forecasts average U.S. demand for petroleum products of 17.23 million b/d, compared with 17.033 million b/d in 1992. This will be the second consecutive year of increased petroleum product demand following 2 years of demand declines.

First half 1993 demand is estimated at 17.115 million b/d. Demand for the second half of 1993 is expected to rise to 17.345 million b/d, which will be up 0.6% from its level in the same period of 1992.

Earlier this year OGJ projected a slightly lower level for 1993 petroleum demand, 17.14 million b/d, and the same rate of increase, 1.2%, from 1992 consumption (OGJ, Jan. 25, p. 57). At that time, OGJ projected first half demand at 16.994 million b/d.

Part of the reason for the change is an upward revision by the U.S. Energy Information Administration (EIA) of 1992 total petroleum product demand. In addition, the economic recovery has stimulated a greater increase in transport fuel demand than had been anticipated.

Total demand, including exports of crude oil and products, will increase 0.8% in 1993 to 18.13 million b/d. Exports are expected to fall this year by 5.2% to 900,000 b/d. Exports during the first half were down 5% at an estimated 900,000 b/d.

Demand will increase for motor gasoline, kerosine jet fuel, distillates, LPG and ethane, and other petroleum products.

Decreases in demand are projected for naphtha jet fuel, which the military is phasing out in favor of kerosine fuel, and for residual fuel oil.

Motor gasoline demand is expected to continue to move up on the strength of a growing vehicle fleet and an increase in miles driven per vehicle, both related to the improving economy.

This will be partially offset by continued improvement in vehicle fuel efficiency. Average motor gasoline pump prices are expected to remain close to 1992 levels and have little impact on demand in 1993.

U.S. SUPPLY OVERVIEW

U.S. crude oil and condensate production will fall to an average of 6.95 million b/d this year. Alaskan output, which started to fall in 1989, will drop by 4.9% in 1993 to 1.63 million b/d.

Lower 48 output is expected to fall to 5.32 million b/d. The drop in total U.S. output forecast for 1993 follows a 3.3% decrease in 1992, an 0.8% increase in 1991, a 3.4% decline in 1990, and a 6.5% decline in 1989. Production in 1993 will be the lowest since 1958.

Petroleum imports will average 8.26 million b/d this year, up 4.7% from 1992.

Total industry stocks will increase by 36 million bbl in 1993, adding 100,000 b/d to demand. The projected crude stock total reflects a 6.9% gain.

Product stocks are projected to increase by 2% to 713 million bbl as a buffer against a demand surge.

Product stocks dipped close to minimum operating levels at 660 million bbl at yearend 1989. Refiners restored them to 712 million bbl at yearend 1990 and 723 million bbl at yearend 1991.

Last year stocks fell to 699 million bbl. Meanwhile, the minimum operating level has been adjusted to 671 million bbl.

Refinery crude runs this year will average 13.5 million b/d, while average refining capacity slips 1.3% to 15.26 million b/d.

PRICE MOVEMENTS

Crude oil prices started out this year slightly ahead of prices a year earlier. By midyear, however, sluggish demand growth and rising production had pushed them to levels substantially lower.

The average price of world export crude oil was $16.92/bbl in the first quarter of this year, compared with $16.33/bbl in the same period in 1992. The price of light sweet crude oil on the New York Mercantile Exchange (Nymex) futures market averaged $19.87/bbl vs. $18.91/bbl in first quarter 1992.

But prices dropped below year-earlier levels in May. The average price of world export crude was an estimated $16.85/bbl in June, compared with $19.68/bbl in June 1992. The Nymex light sweet crude price averaged $19.08/bbl in June vs. $22.40/bbl a year earlier.

In general, crude prices for all of the first half were 1-2% lower than they were in the same period of 1992. The worldwide export price averaged $17.01/bbl in the first half, down 1.9% from the same period of 1992. The Nymex futures price averaged $19.83/bbl, down 1%.

The markets have interpreted the June OPEC agreement as an invitation to group members to cheat. Near-quota output would indeed raise prices by keeping oil supplies below expected demand. But Kuwait's defiance means other members would have to cut production deeply, which isn't likely.

Saudi Arabia produced more than 8 million b/d through the first half and thus has room for significant cuts. But it would insist on cooperation from other members that it probably wouldn't receive.

A greater test for OPEC will come when the United Nations lifts its ban on exports from Iraq. Unless demand for OPEC oil rises significantly before that happens, Iraqi oil could prove more difficult for the group to handle than Kuwait's recovered production because it will represent a sudden increase in supply.

THE CALL ON OPEC

According to the International Energy Agency (IEA), demand for OPEC crude oil averaged 25.1 million b/d during the first quarter and dropped to an estimated 23.9 million b/d in the second quarter.

Demand for OPEC crude will move up to 24-25 million b/d in the third quarter, depending on stock changes.

IEA has estimated average OPEC output during April and May at 24.15 million b/d, slightly above quota and estimated second quarter demand for OPEC oil. This is a major reason for recent price weakness.

The expected increases in demand for OPEC oil in the third and fourth quarters should prevent a price collapse even if OPEC has trouble restraining production.

Crude prices in the second half also will depend upon strength of the economic recovery in Europe and the U.S. and management of petroleum stocks.

Prices appear set to firm when refiners are building stocks to meet demand for the Northern Hemisphere winter, probably late in the third quarter and early in the fourth.

The U.S. wellhead price of crude oil averaged $14.85/bbl for January and February, compared with $14/bbl a year earlier. Last year, the price moved up to $17.95/bbl in June and then slipped back to $14.94/bbl in December.

OGJ projects an average U.S. wellhead price of $15.65/bbl for 1993, compared with $15.98/bbl in 1992.

U.S. product prices have been following the price of crude oil, starting above year-ago levels and falling as the year progresses. However, the slide for products has not been as pronounced as for crude oil because of product demand strength related to economic recovery.

U.S. PRODUCT PRICES

The OGJ survey of self-service unleaded motor gasoline pump prices shows a first half average of $1.115/gal vs. $1.097/gal last year. The increase has apparently been in retail margins.

The average wholesale price dropped to 61.6cts/gal from 63.8cts/gal in first half 1992. The pump price at the end of June was $1.09/gal, down from $1.176/gal a year earlier.

State and federal gasoline taxes for the first half of 1993 averaged 32.1cts/gal, the same as in 1992.

The gasoline price decline in the face of rising demand reflects lower crude oil costs and competition.

OGJ projects the pump price for all types of motor gasoline, including premium grades, to average $1.20/gal for 1993, up from $1.19/gal for 1992. This small increase results from the midyear price weakness.

The average U.S. pump price for all grades of motor gasoline peaked in 1981 at $1.353/gal.

Residential heating oil prices for the first 3 months of 1993 averaged 94.8cts/gal, up from 93.6cts/gal in the same period last year. The increase was mainly due to stronger demand during the cool first quarter this year.

OGJ expects heating oil prices to average 94cts/gal for the year vs. 93.4cts/gal last year as stronger distillate heating oil demand more than offsets the effects of declining crude costs.

U.S. GAS PRICES

Average U.S. natural gas prices are expected to be up sharply this year. Strong demand during the first half pushed prices to well above levels of a year earlier.

OGJ projects an average U.S. wellhead price of $2.20/Mcf for 1993, up from $1.86/Mcf for 1992. This is based on an expected 2.5% increase in U.S. natural gas consumption.

The first half average of spot gas prices reported by Natural Gas Clearinghouse was $1.978/Mcf, up 44.7% from the same period last year. The Nymex futures market gas price for the week of June 18 was $2.21/MMBTU, up 40.8% from the same week in 1992.

In 1992 prices strengthened in the second half, so the annual average year to year increase in wellhead prices is not expected to be as great as was exhibited by spot and futures prices during the first half of 1993.

Gas prices peaked in 1984 at $2.66/Mcf, then dropped sharply as demand weakened, failing to $1.67/Mcf in 1987. The average annual price was relatively constant the next several years, increasing to $1.71/Mcf in 1990 but falling to $1.64/Mcf in 1991.

This year's projected 18.3% increase in the average gas price follows a 13.4% jump last year.

Even during the years of relatively constant prices there have been pronounced seasonal swings related to seasonal demand changes. Seasonal price fluctuations are expected to continue but to be somewhat less pronounced than before due to increased industrial and utility demand unrelated to heating requirements.

THE U.S. ECONOMY

Low interest rates will boost investment and keep the sluggish economic recovery under way in the U.S. In addition, increases in industrial production, auto sales, and housing starts will bolster growth this year.

Concerns remain, however, about the rate of growth and even about a possible return to recession.

In the first quarter, the U.S. gross domestic product (GDP) grew at the rate of only 0.7%/year. The weakness was attributed partially to recession in Europe.

Late in 1990 the U.S. economy entered its first recession since 1982. The slow recovery is not typical of the early growth months after a recession and has made economists fear a quick resumption of the slump.

Before the latest recession, the U.S. economy had grown for 8 consecutive years, a post-World War II record. GDP increased by 29.9% during the period, an average rate of growth of 3.3%/year. Growth slowed in 1990, with GDP moving up only 1%. In 1991 GDP fell by 0.7%.

OGJ expects 1993 GDP to grow by 2.7% from its 1992 level. Last year GDP increased 2.1%.

Industrial production is expected to increase an estimated 3.5% after rising by 1.5% in 1992. New car sales are expected to move up to 9 million in 1993 from 8.4 million in 1992. This is still down from new car sales of 9.9 million in 1989 and 9.5 million in 1990. Housing starts are projected to increase to 1.3 million from 1.2 million in 1992.

U.S. ENERGY DEMAND

Energy consumption will increase modestly in the U.S. this year, primarily due to the expected increase in economic activity.

After declining in the early 1980s, energy consumption moved up 14.7% during the 8 years of expansion that ended at the end of 1990. This amounts to average growth of 1.7%/year, about half the average growth rate of GDP.

Energy consumption fell by 0.1% in 1990 and 1991 before moving up 1.2% last year as the economy began to recover.

Although energy consumption will rise with increased economic activity, the growth rate will be dampened by increased energy use efficiency. The rate of improvement in energy efficiency will depend on the cost of energy in relation to other production costs.

Since 1970 growth in energy consumption has lagged that of GDP, indicating improvement in the level of economic output relative to energy input. However, the rate of growth in energy consumption tends to track closer to GDP growth during periods of rapid economic expansion and during periods of low energy costs.

Energy consumption per unit of GDP fell from 23,300 BTU/$ of GDP in 1970 to 16,700 BTU/$ in 1992. The OGJ projection is for energy consumption per unit of GDP to fall to 16,600 BTU/$ in 1993.

Total energy consumption will move up 1.8% to 83.67 quadrillion BTU (quads) for 1993. This follows an increase of 1.2% in 1992 and a decline of 0.1% in 1991.

Oil energy demand is expected to move up 1.2% in 1993 to 33.86 quads. Energy from oil increased 1.9% in 1992.

Oil's share of total energy demand will slip to 40.5% in 1993 from 40.7% in 1992 but will be up from 40.4% in 1990. Oil's share of the energy market reached its highest level in 1978 at 48.6%.

Demand for energy from natural gas will move up 2.5% this year to 20.62 quads after a 2.1% increase last year. The gas market share will increase to 24.6% from 24.5% in 1992 and 24.3% in 1991.

Oil and natural gas thus will provide 65.1% of the energy consumed in 1993, compared with 65.2% in 1992 and 64.7% in 1991.

Coal energy demand will rise by 1.7% in 1993 to 19.26 quads following a 0.9% increase in 1992. Coal's market share will remain at 23%.

Energy from hydroelectric and other energy sources will increase 7.7% in 1993 to 3.24 quads, as increased rain and snowfall during the past year boost hydroelectric output. This follows a 9.3% decline from hydroelectric and other sources last year.

The market share in this category will move up to 3.9% in 1993 from 3.7% in 1992. Drought in the western U.S. has suppressed hydroelectric production in the past several years. Other energy sources such as geothermal, wind, wood, and solar provided only 0.3% of total energy consumed in the U.S. in 1992.

Nuclear energy output is expected to increase 0.7% this year to 6.69 quads. This follows a 1% increase last year. Nuclear's market share is expected to slip to 8% this year from 8.1% the last 2 years.

Nuclear energy output has risen slowly in recent years, mainly because of an increase in capacity utilization. No new units are being added, however, and total capacity has started to decline. This will probably lead to only modest growth and possibly even a decline in nuclear energy output in future years.

This slowing of the growth in nuclear power generation will force the electric power industry to turn to other fuel sources in the future, probably coal and natural gas.

U.S. NATURAL GAS

Consumption of natural gas is expected to increase 2.5% in 1993 to 20.02 tcf. This follows gains of 2.1% in 1992 and 2.2% in 1991.

Gas consumption rose from 16.221 tcf in 1986 to 19.53 tcf in 1992. The record high for gas consumption was 22.049 tcf in 1972. Demand fell when prices jumped in the late 1970s and early 1980s, reaching the recent low of 16.221 tcf in 1986.

Subsequent price declines helped boost demand during the recent recovery period. During 1987-91, gas prices averaged $1.68/Mcf, well below the peak of $2.66/Mcf in 1984. The lower prices helped gas compete with residual fuel oil and coal.

The industrial sector accounted for 55.6% of the increase in gas consumption during 1986-92, but demand rose in other sectors as well. Demand gains during the period included 33.5% in the industrial sector to 7.448 tcf, 19.5% in the commercial sector to 2.771 tcf, 9% in the residential sector to 4.703 tcf, and 6.3% in the utility sector to 2.766 tcf. Consumption of gas as a pipeline, lease, and plant fuel increased 30.8% to 1.842 tcf.

Last year, the industrial sector posted the largest percentage increase in gas consumption, 3.2%. Consumption in this sector is expected to rise by 3.1% this year to 7.676 tcf.

Residential demand will increase 3% to 4.842 tcf on the strength of housing construction and conversions to gas. This follows a 3% increase in 1992. Commercial consumption will rise 1.7% to 2.818 tcf.

In the utility sector natural gas will continue to face stiff price competition from coal. According to the U.S. Energy Information Administration, the cost of coal for steam electric utilities has dropped from $1.455/MMBTU in 1990 to $1.414/MMBTU in 1992. The cost of natural gas for these utilities was $2.321/MMBTU in 1990, $2.153/MMBTU in 1991, and $2.329/MMBTU in 1992.

Coal's price advantage thus has increased during the past couple of years. And the expected increase in hydroelectric output will reduce the need for power from other generating facilities.

But natural gas has environmental advantages and is the favored fuel for the small power generators that have provided most incremental capacity in recent years. For these reasons, electric utility consumption of natural gas is expected to move up 1% in 1993 to 2.795 tcf.

Consumption of gas as a lease, plant, and pipeline fuel is expected to move up 2.6% to 1.889 tcf this year.

U.S. marketed production of natural gas will increase by 2% to 19 tcf. This follows an increase of 0.2% in 1992 to 18.621 tcf.

U.S. gas production has fluctuated with demand. Output peaked at 22.648 tcf in 1972 but slipped to a recent low of 16.859 tcf in 1986.

Since then production has risen and been supplemented by growing volumes of imported gas, mainly from Canada. Imports rose from 756 bcf in 1986 to 2.083 tcf last year. Gas imports are projected to increase 9.9% in 1993 to 2.29 tcf. Last year's increase was 17.5%.

Imports from Canada will total 2.22 this year, up 8.8%, following a 19.3% increase last year. Imports of liquefied natural gas from Algeria will increase to 70 bcf this year from 43 bcf in 1992.

U.S. PRODUCT DEMAND

During the first half of the year, U.S. demand for petroleum products was stronger than the weak economic growth would normally indicate.

Demand in the first half was up 1.7% from the same period a year earlier.

Increased economic activity did contribute to the increase in demand, but another major factor was the return to nearly normal weather during the first part of the year after several unusually warm winters.

Heating degree days for the first 4 months of 1993 were up 11.3% from the same period a year ago but still showed conditions 1.2% warmer than normal.

First half demand for distillate moved up 4.3% from its level a year earlier to 3.15 million b/d.

Economic growth and cooler weather pushed up first half demand in all other major product categories except resid.

Demand for petroleum products fell in 1990 and 1991 after growing steadily during 1984-89. The downturn resulted from energy efficiency improvements and the economic slump.

Product demand peaked at 18.847 million b/d in 1978 and fell to as low as 15.231 million b/d in 1983. The economic expansion of 1982-90 helped raise demand to 17.325 million b/d in 1989.

During the first half of this year, demand for motor gasoline was up 1.1 % from its level of the same period of 1992, averaging 7.23 million b/d.

Relatively steady pump prices for gasoline have helped stimulate demand in a recovering economy.

The projected 0.6% demand gain for motor gasoline will take the year's average to 7.31 million b/d.

In 1992 motor gasoline demand moved up 1.1% after falling 2% during 1988-91. Demand fell from 7.336 million b/d in 1988 to 7.193 million b/d in 1991.

The record high for motor gasoline demand was 7.412 million b/d in 1978. The next highest years were 1988 at 7.336 million b/d and 1989 at 7.328 million b/d.

Increases are expected in the size of the vehicle fleet and the average miles driven per vehicle. They will be partially offset by an improvement in vehicle fuel efficiency.

The vehicle fleet grows with the population and average age. Miles driven is a function of the economy's health and the discretionary spending of drivers.

In recent years, improvement in vehicle fuel efficiency has slowed.

DISTILLATE GROWTH

For the entire year OGJ projects distillate demand of 3.06 million b/d, vs. 2.979 million b/d in 1992, with increases in all economic sectors. Cooler weather is expected to boost consumption even in the residential and commercial markets, where conversions to natural gas have dampened demand in recent years.

For the remainder of the year transportation will lead distillate demand. Distillate consumption rates in the industrial, farm, and utility sectors are also expected to move up with the improvement in the economy.

Demand for residual fuel oil in the first half was down 7.3% from first half 1992, averaging 1.06 million b/d. Natural gas and coal are eroding resid's heating markets.

During the early part of the year heavy fuel oil prices were up substantially from the level a year earlier. According to EIA the residual fuel oil wholesale price for January and February this year averaged 31.35cts/gal, up 27.4% from the same period in 1992.

Gas prices increased more than that but coal prices were down from year earlier levels.

Utilities thus turned to coal as a fuel source, and heavy fuel oil consumption fell.

Electric utility petroleum consumption (primarily resid) for the first 2 months of this year was down 23% from the same months of 1992.

For the year, resid demand is projected at 1.05 million b/d, compared with 1.094 million b/d in 1992.

Resid demand during the second half is projected at 1.04 million b/d, down only 0.6% from the same period of 1992. The jump in natural gas prices and the slump in resid prices at midyear should make resid more competitive as a boiler fuel for utilities and industry with fuel switching capability.

Demand for LPG and ethane is projected to average 1.78 million b/d in 1993, up 1.4% from 1992. Demand during the first half was up 1.5% at 1.73 million b/d. Chemical demand is up along with increased residential/commercial demand accompanying cooler weather.

Demand for all of the other petroleum products is also expected to increase this year by 1.9% to 2.53 million b/d. Demand in this category during the first half of 1993 averaged 2.46 million b/d, up 3.1% from 1992. Included in this product category are petrochemical feedstocks, special naphthas, lubricants, waxes, petroleum coke, asphalt and road oil, still gas, and miscellaneous products.

U.S. SUPPLY

The 4.4% decline in U.S. production of crude oil and lease condensate during the first half took the average to 6.97 million b/d.

Alaskan production in the first half averaged 1.633 million b/d, Lower 48 production 5.337 million b/d.

The natural decline in North Slope production is increasingly obvious. Until now, the region's declines have had nonrecurring explanations: the Exxon Valdez spill of 1989, which curtailed output; pipeline and pump station maintenance projects that reduced flow in the summer of 1990.

Alaskan production had been as high as 2.031 million b/d during first half 1988 and averaged 2.017 million b/d that year. It fell to 1.874 million b/d in 1989 and 1.773 million b/d in 1990.

After completion of the pipeline maintenance project of 1990, Alaskan production moved up to 1.798 million b/d in 1991. In 1992, however, it fell to 1.714 million b/d.

Total U.S. output in 1992 averaged 7.171 million b/d, compared with 7.417 million b/d in 1991.

The rate of decline in U.S. output is expected to slow in the second half of this year. Steady crude oil prices should encourage investment in secondary recovery projects, workovers, and similar projects.

OGJ projects second half output of 6.93 million b/d and full-year output of 6.95 million b/d.

Alaskan production will be down slightly from the first half average at 1.628 million b/d due to summer maintenance projects.

Lower 48 output will slide to 5.302 million b/d.

Total U.S. output this year will be down 22.5% from the recent high of 8.971 million b/d in 1985.

Relatively stable oil prices and relief from the alternative minimum tax have provided some encouragement for drilling. And producers are using increasingly sophisticated techniques to improve drilling success rates.

These trends should help slow the production decline rate. No reversal can occur, however, until drilling and completion rates increase significantly from current levels.

The all time high in U.S. oil production came in 1970 at 9.637 million b/d. Production then slipped to 8.132 million b/d in 1976 just prior to the addition of North Slope output. Increases in Alaska and a boom in Lower 48 drilling pushed production up to 1985's recent peak.

Production has been sliding since 1986 due to a price slump, a drilling lull, and the North Slope decline. Low drilling and the North Slope decline will keep production falling in future years.

Production of natural gas liquids (NGL) and other liquids averaged 2 million b/d for the first half of 1993, up 11.8% from the year before. Production of NGL and other liquids is projected to average 1.99 million b/d for the year, up 9% from 1992.

Part of the increase is due to additional NGL output, but much of the increase is attributable to a change in EIA's definition of "other liquids supplied."

Starting in 1993 this category includes oxygenates from methyl tertiary butyl ether (MTBE) plants and fuel ethanol.

With this spurt in NGL and other liquids, the decline in total liquids production is not as pronounced as indicated by the fall in crude output.

U.S. total liquids production is projected to average 8.94 million b/d for 1993, a decline of only 0.6% from the year before. But total liquids production is still down 15.9% from the 10.636 million b/d in 1985.

U.S. REFINING TRENDS

U.S. refining capacity may be starting to decline due to costs related to new environmental regulations. Operable capacity was down 1.9% in the first half of this year at 15.29 million b/d. It is projected that capacity will average 15.26 million b/d for the year, down 1.3% from 1992.

During 1984-92, U.S. refining capacity has remained in a range of about 15.5-15.9 million b/d. Last year, capacity averaged 15.46 million b/d.

Capacity peaked at 18.8 million b/d in 1981. Product demand rose steadily throughout the 3 previous decades, and capacity moved up to meet demand, peaking 3 years after demand. More recently, with capacity fairly steady, increases in refinery inputs matching demand gains have significantly raised capacity utilization rates.

Refinery utilization dipped below 70% in 1981 and 1982 but now approaches 90%.

Crude input to refineries is projected to be up 0.7% this year at 13.5 million b/d, and total input to distillation units will also move up 0.7% to 13.7 million b/d. The increased input coupled with the slide in capacity accounts for the expected gain in the average utilization rate, which will reach 92.1% in the third quarter.

A study issued last year by the consulting firm Wright Killen concluded that an additional 1.5 million b/d of capacity may be shut down soon due to the costs of new environmental regulations.

If that takes place there will not be sufficient U.S. refining capacity to meet expected petroleum demand. The condition is inevitable even without the shutdowns as demand grows and refining capacity remains constant. Eventually, therefore, the U.S. will have to increase its imports of products.

U.S. IMPORTS

The expected increase in imports this year will be the second consecutive yearly gain following 2 declines associated with economic recession.

For the first half total industry imports, excluding crude for the Strategic Petroleum Reserve (SPR), were up 8.1% at 8.19 mil]ion b/d. Industry imports are expected to rise to 8.33 million b/d in the second half due to the increase in demand and lower domestic liquids production.

The expected 4.7% increase in total imports this year follows a 3.3% gain last year.

Imports peaked in 1977 at an annual average of 8.786 million b/d. They reached a recent record low of 4.949 million b/d in 1985 as high oil prices reduced demand and encouraged domestic production.

Imports moved back up to 8.061 million b/d in 1989 then retreated for 2 years due to weak petroleum demand related to the economic slowdown.

Crude imports, excluding the SPR, are projected to increase 4.9% in 1993 to 6.37 million b/d. Crude imports increased 5% last year. During the first half of this year crude imports averaged 6.4 million b/d, up 10.6% from first half 1992.

Crude imports by the government for the SPR were resumed last June and averaged 10,000 b/d for all of 1992. SPR imports ceased in August 1990, when Iraq invaded Kuwait. They had been averaging about 55,000 b/d.

OGJ projects SPR imports at 40,000 b/d during 1993, with SPR stocks increasing by 15 million bbl during the year.

Petroleum product imports will increase by 4.8% this year to 1.89 million b/d. During the first half product imports averaged 1.79 million b/d, down 0.1% from the same period of 1992.

Increased product demand in the second half and the stock replenishment will boost second half product imports to 1.99 million b/d, up 9.5% from the second half of 1992.

During the first quarter of this year, the leading source of U.S. crude imports was Saudi Arabia, which supplied 1.466 million b/d. Last year U.S. imports of Saudi crude averaged 1.597 million b/d. Total crude imports from OPEC countries averaged 3.616 million b/d in the first quarter, up 8.1% from the level in 1992. Crude imports from OPEC represented 57.2% of the total crude imports in the first quarter this year.

First quarter product imports were down 2.6% at 1.758 million b/d. Venezuela was the leading source with 368,000 b/d, up 7% from the import level for 1992. Product imports from OPEC averaged 722,000 b/d, up 5.9% from 1992.

Total imports from OPEC during the first quarter of this year averaged 4.338 million b/d, up 7.7% from the import level in 1992. This was 53.7% of total U.S. imports in the first quarter vs. 51% in 1992.

U.S. STOCKS

Industry stocks at the end of 1992 totaled 1.017 million bbl, 3% below their level at the end of 1991, leaving the industry vulnerable to an unexpected increase in product demand.

This year, stocks have increased, surpassing year-earlier levels. At midyear, crude stocks totaled an estimated 350 million bbl, compared with 325 million bbl at the end of June 1992 and only 318 million bbl at yearend 1992.

EIA considers 320 million bbl the minimum operating level for crude stocks. Crude stocks are expected to fall slightly from midyear levels to 340 million bbl at yearend. For the past several years the industry seems to have targeted 340-350 million bbl as a comfortable level for yearend crude stocks.

At the end of the first half of this year product stocks were an estimated 690 million bbl, vs. 699 million bbl at yearend 1992 and 708 million bbl at midyear 1992. At the end of the first quarter this year product stocks were close to minimum operating levels at only 663 million bbl.

Refiners generally have been more willing to deplete product stocks than crude stocks. Crude stocks provide refiners the flexibility to meet a surge in demand for any product. With capacity utilization high, however, refiners may have difficulty stepping up throughput to meet demand surges and thus may have to add to product inventories. At yearend 1992 total industry stocks represented only 59.7 days of supply at 1992 demand levels. This was down from 62.7 days at yearend 1991. At yearend this year the increased stock level is expected to equate to 61.1 days of current demand, providing a little better cushion for refiners.

SPR inventories have fluctuated as a result of test withdrawals in 1990 and 1991, the pause in SPR imports during the Persian Gulf crisis, and the resumption of imports in June 1992.

SPR stocks will increase with the rise in imports expected this year as well as the addition of domestic crude.

At midyear 1993 SPR stocks totaled an estimated 584 million bbl, up from 570 million bbl a year earlier but below the peak of 590 million bbl in 1990. They will return to 590 million bbl by yearend.

WORLDWIDE TRENDS

The challenge facing OPEC, as always, is to balance the market. It must coordinate production to satisfy demand for its members' crude without overproducing and wrecking prices.

And it must do so despite its members' varying revenue needs, the usual source of group conflict over production and price targets.

OPEC's task was made easier by the relative balance between OPEC production capacity and the call on OPEC crude that lasted through most of 1992. Further help came from declining production from the U.S. and former Soviet Union, which elevated demand for OPEC oil. For the 2 years following Iraq's invasion of Kuwait, therefore, OPEC members could essentially produce at will without weakening prices. Saudi Arabia and, to a lesser extent, the United Arab Emirates limited output when necessary during this period of stability.

With Kuwait back on stream, however, available OPEC production capacity has increased to an estimated 26-27 million b/d. With the call on OPEC crude estimated by IEA to average significantly less in the second and third quarters, OPEC production at available capacity would create a dangerous surplus. That's why restraint is crucial to the market's health. OPEC's second and third quarter quota is 23.582 million b/d, below anticipated demand for OPEC crude of 24-25 million b/d.

But Kuwait will produce at least 400,000 b/d more than its 1.6 million b/d quota, and other members are likely to ignore their assigned ceilings as well. In the absence of an agreement that all members take seriously, the question is whether price weakness will be enough to enforce production restraint until demand rises later in the second half. Since the crude price collapse of 1986, the result of a deliberate effort by Saudi Arabia and others to reclaim market share, OPEC has had only intermittent success in its market balancing efforts.

When members don't adhere closely to their quotas, or the group sets overly optimistic ceilings and production at quota still exceeds demand for OPEC crude, prices weaken. Then, when low prices depress revenues, members pull production back in line with quotas.

This intermittent production discipline has created a seesaw effect for prices in recent years.

IEA estimated OPEC crude production in May 1993 at 24.19 million b/d, about 600,000 b/d above the quota. It projects demand for OPEC oil at about 23.9 million b/d in the third quarter if there is little net change in worldwide stocks-close to the OPEC quota.

THE PRICE SLIDE

The average price of world export crude oil slipped to $16.75/bbl in the second week of June from $17.52/bbl in the first week in May. The average export price of OPEC crude fell to $16.42/bbl from $17.09/bbl in the same period.

OPEC has tried to stabilize prices of a basket of seven world export crudes at $18-20/bbl, but in the first half the crudes traded at $17-18/bbl.

According to IEA, total worldwide demand averaged about 67.2 million b/d during the first half, down 100,000 b/d from the same period of 1992. A sharp drop in consumption in the Commonwealth of Independent States is a major reason. Estimated total worldwide oil supply in the first half averaged 66.8 million b/d, the same as in first half 1992.

OPEC total liquids output moved up to 26.7 million b/d from 25.8 million b/d in first half 1992. This gain was offset by a drop of 1 million b/d in non-OPEC supply to 40.1 million b/d. The decline reflects a 1.2 million b/d drop in C.I.S. liquids production to a first half average of 8.2 million b/d.

In addition to OPEC production and worldwide demand, stock management will be crucial to oil markets as the Northern Hemisphere winter raises consumption.

IEA reports that stocks held by members of the Organisation for Economic Cooperation and Development (OECD) as of the end of first quarter 1993 exceeded year-earlier levels but fell below inventories at the the first of the year. Total OECD stocks on hand as of the end of the first quarter were 3.343 billion bbl, up 29 million bbl from a year earlier but down 44 million bbl from the start of the year. Company held stocks were at 2.285 billion bbl, down 7 million from a year earlier and down 51 million from the start of the year.

Total stocks at the end of the first quarter represented 96 days of forward consumption, compared with 93 days as of Jan. 1 and 97 days a year earlier. Industry stocks, however, represent only 66 days of supply vs. 67 days a year earlier. Industry stocks have ranged 65-70 days of forward consumption for the past 7 years.

OUTLOOK

IEA projects a 400,000 b/d increase in worldwide demand for petroleum products to 67.5 million b/d for the full year. This includes a projected 400,000 b/d increase in North American demand and a 900,000 b/d drop in C.I.S. demand.

In Western Europe, demand is expected to be off 100,000 b/d. The largest increase in the developing countries will be in Asia, where demand is projected to move up 400,000 b/d.

For the year, IEA projects a 700,000 b/d drop in non-OPEC supply to 40.2 million b/d. This will mean that to meet demand an additional 1.1 million b/d will have to come from stocks or from OPEC.

Assuming that with rising demand there will be little change in the stock level in 1992, this translates into demand for OPEC crude oil and NGL averaging 27.3 million b/d for the year. This is up 1.1 million b/d from the estimate of 26.2 million b/d of OPEC liquids output in 1992.

The actual increase in demand for OPEC oil will depend upon the change in stock levels. If there are net additions in 1993, demand for OPEC oil will move up. And if stocks are reduced the demand for OPEC oil will fall. IEA estimates there was no net change in worldwide stocks last year.

Demand for OPEC total liquids is projected to increase to 27.2 million b/d in the third quarter and 28.6 million b/d in the fourth quarter. OPEC output of NGL is estimated at a constant 2.2 million b/d for the year.

Therefore, demand for OPEC crude oil is projected to move up to 25 million b/d in the third quarter and to 26.4 million b/d in the fourth quarter. This will keep demand for OPEC crude oil within available capacity even in the fourth quarter and should prevent any surge in prices later in the year. The IEA assumes modest economic growth for the OECD economies. It projects an economic growth rate of about 1.2% in 1993, down from 1.5% in 1992.

The IEA estimate for U.S. GDP growth this year is 2.6%. Japan's GDP growth rate is expected to fall to 1% from 1.3%. Germany's GDP will fall 1.9% this year after a 2% gain in 1992.

If these economies outperform expectations, fourth quarter demand will exceed projections, perhaps by enough to push the call on OPEC crude to near OPEC production capacity. That, in turn, would strengthen prices. Lower than anticipated economic growth would have the opposite effect, intensifying OPEC's difficulties in keeping oil supply in balance with demand.

Copyright 1993 Oil & Gas Journal. All Rights Reserved.