DEMAND KEY FACTOR IN WORLDWIDE CRUDE PRICES AND DRILLING

Robert J. Beck
Economics Editor

The global demand surge that rescued world crude oil prices in 1994 will continue through 1995 and at least sustain, if not increase, worldwide drilling activity.

Although average world crude oil prices at the end of 1994 were somewhat higher than a year earlier, the average price for all of last year was down from that of 1993. Prices started the year very weak but gathered strength as worldwide petroleum demand growth exceeded expectations.

Production capacity remained sufficient to meet the growing need for crude, and the potential for return of Iraqi exports, embargoed by the United Nations since August 1990, lingered over the market. Attempts by the Organization of Petroleum Exporting Countries (OPEC) to balance the market were hampered by increases in non-OPEC crude output in 1994.

For several years the average world export crude oil price fluctuated seasonally within the range of $16-20/bbl. This band appears to have dropped to $13-17/bbl.

The increase in world demand will be the greatest factor in the market in 1995. As economic activity increases, petroleum demand is projected to rise among the industrialized-nation members of the Organisation for Economic Cooperation and Development (OECD) and in developing countries outside the Former Soviet Union (FSU).

Economic developments in the FSU remain crucial. The region's difficult transition to a new economic system has dragged down crude oil production and petroleum use. Regional exports have not slumped nearly as much, but that will change when consumption recovers. Timing of that recovery is a major question for the market.

As always, political and economic changes in the producing countries of the Middle East would affect petroleum supplies, prices, and industry activity but are impossible to predict.

ECONOMIC GROWTH RATES

Strength in petroleum demand this year and last is mainly a function of strengthening economies around the world.

Economic growth continued last year in the U.S. and Asia. In Europe, Germany, France, and Italy joined the U.K. in recovery. And Japan's economy started to pull out of stagnation.

According to OECD estimates, real gross domestic product (GDP) for OECD North America moved up 3.9% in 1994 after a gain of 2.9% the year before. GDP for OECD Europe moved up 2.3%, compared to a decline of 0.1% in 1993. For all of the OECD countries, the economic growth rate improved to 2.8% in 1994 from 1.3% in 1993.

Japan's GDP growth rate was a minuscule 0.1% in 1993 but rose to 1% in 1994. The U.S. GDP growth rate improved to 3.8% from 3.1% the year before, and Canada's growth rate jumped to 4.1% from 2.2% in 1993.

The GDP growth rate for OECD Europe is projected to move up again in 1995 to 3%. Japan's economic growth rate is expected to improve to 2.5% in 1995. U.S. GDP growth will slide to 3.1% this year, while Canada's will increase to 4.2%.

The rate of growth for all of the OECD in 1995 is estimated at 3%.

For the world outside of OECD and the FSU, the International Monetary Fund (IMF) projects combined GDP growth of 5.6% this year, the same rate as last year. Growth in this area in 1993 was 6.1%.

The strongest growth will again be in the developing countries of Asia, which posted GDP growth of 8.5% in 1993 and 8% in 1994. Their combined growth is projected at 7.3% in 1995. African growth is projected at 4.5% vs. 3.3% in 1994. Developing countries in the Western Hemisphere are expected to experience combined economic growth of 3.3% vs. 2.8% in 1994.

The IMF classifies Russia and the countries of central and eastern Europe as countries in transition for which data collection problems prohibit accurate assessments of GDP. IMF does, however, publish gross output and other numbers for this group. For countries in transition, total economic output fell 9% in 1993 and 8.3% in 1994, IMF says. It expects the decline rate to fall to 1% in 1995.

Russia's total output fell an estimated 12% in both 1993 and 1994 and is projected to slip 3.9% this year. Output in central and eastern Europe dropped 5.7% in 1993 and 5.4% in 1994 but is expected to grow by 1.4% in 1995.

WORLDWIDE DEMAND

Worldwide Supply and Demand (17901 bytes)

Continued economic growth means further gains in petroleum consumption.

Last year, worldwide demand for petroleum products strengthened as consumption moved up in the OECD countries and in developing countries other than the FSU. Generally, those trends will continue.

According to estimates by the International Energy Agency (IEA), worldwide consumption of petroleum products increased 1.1 million b/d to average 68.2 million b/d in 1994. World demand was down 100,000 b/d in 1993 at 67.1 million b/d.

The IEA projects that total world demand will move up 1.1 million b/d in 1995 to 69.3 million b/d. OECD demand is expected to move up 400,000 b/d to average 40.4 million b/d. Non-OECD demand excluding the FSU is projected to increase 1 million b/d to 24.4 million b/d. FSU demand is expected to fall 300,000 b/d to an average 4.5 million b/d.

Last year, OECD demand increased 900,000 b/d to 40 million b/d, and non-OECD demand excluding the FSU increased I million b/d to 23.4 million b/d. This was partially offset by an 800,000 b/d drop in FSU consumption to 4.8 million b/d.

The growth in OECD petroleum demand this year will be in both North America and Europe. In North America demand will move up 200,000 b/d to average 19.9 million b/d. European demand will average 13.9 million b/d, also up 200,000 b/d. Demand in OECD Pacific is expected to remain at about 6.6 million b/d.

Last year demand in North America increased by 500,000 b/d. OECD Pacific demand moved up 300,000 b/d as Japan emerged from recession, and there was strong economic growth in Australia and New Zealand. Demand in OECD Europe moved up 100,000 b/d.

The largest demand increase will again occur in non-OECD Asia: 400,000 b/d to 7.6 million b/d. Latin American demand is expected to move up 100,000 b/d to 5.8 million b/d, and Middle East demand will advance 300,000 b/d to 4.2 million b/d. Demand in China is expected to increase 200,000 b/d to 3.3 million b/d, while demand in Africa and East Europe will remain close to 1994 levels.

In 1994, several non-OECD areas posted significant increases in oil demand. Asian petroleum demand moved up 400,000 b/d to 7.2 million b/d. Middle East demand rose by an estimated 100,000 b/d to 3.9 million b/d. Latin American demand was up 100,000 b/d at 5.7 million b/d, and in China demand increased by the same amount to 3.1 million b/d.

FSU demand has plummeted in the past 4 years. In 1994 the decline amounted to 800,000 b/d, pulling the year's average down to 4.8 million b/d. With consumption declining more slowly, FSU demand this year will average 4.5 million b/d.

Until last year, FSU demand declines had offset gains elsewhere, keeping worldwide demand from growing significantly for several years.

Worldwide demand edged up from 66 million b/d in 1989 to 67.2 million b/d in 1992 then slipped to 67.1 million b/d in 1993. Total world demand thus increased by only 1.7% during 1989-93. In the same period, FSU demand fell from 8.8 million b/d in 1989 to 5.6 million b/d in 1993. By the end of last year, FSU consumption had fallen 45% in 5 years.

Worldwide petroleum demand excluding the FSU moved up from 57.2 million b/d in 1989 to 63.4 million b/d in 1994. Thus, two thirds of a 6.2 million b/d gain in world demand outside the FSU was offset by the FSU's consumption slide in the last 5 years.

Growth in OECD demand for petroleum products has been volatile and closely associated with economic growth.

OECD demand bid inched up from an average 37.8 million b/d ill 1989 to 38.1 million b/d in 1990 ind 38.2 million b/d in 1991. In that period, increases in OECD Europe ind Pacific were offset by declines in North America, where consumption fell from 19.3 million b /d in 1989 to 18.9 million b /d in 1990 and 18.6 million b/d in 1991.

GDP growth for the OECD slipped from 3.3% in 1989 to 2.6% in 1990 and only 1% in 1991.

U.S. economic recovery lifted the OECD growth rate to 1.6% in 1992 but was partly offset by declines in Japan and Germany. Even though the U.S. economy strengthened further in 1993, the OECD economic growth rate slumped to 1.3% as France, Italy, and Germany went into recession and Japan's economic growth became negligible.

WORLDWIDE SUPPLY

OPEC production was steady in 1994 as members kept total production at slightly above the group quota of 24.5 million b/d set in late 1993.

With OPEC holding production close to quota, consumption growth during 1994 strengthened prices for most of the year despite new production from outside the exporters' group.

Most of the increase in non-OPEC output came from the U.K. and Norwegian North Sea.

Non-OPEC supply moved up 700,000 b/d in 1994 despite a decline of the same amount in FSU production. The non-OPEC increase blunted OPEC's hopes of holding crude prices at a target level of $20/bbl.

During 1991-92, with Iraq off stream due to the embargo and Kuwaiti production rebuilding from war damage and with FSU production falling, OPEC countries were able to produce close to capacity and even increase output. In 1993, however, the decline in FSU production was more than offset by a combination of increasing non-OPEC production and falling consumption, including that of the FSU. Prices slid during the last half of 1993 and into 1994.

IEA estimates OPEC crude oil production averaged 24.9 million b/d in the first quarter of 1994, 24.8 million b/d in the second quarter, and 24.9 million b/d in the third quarter. OPEC production is expected to have averaged close to 24.6 million b/d for the fourth quarter of 1994, for which final data are not yet available. This would result in average output for the year of 24.8 million b/d, compared with 24.7 million b/d in 1993.

WORLDWIDE SUPPLY OUTLOOK

IEA projects another increase in non-OPEC supply in 1995. Including processing gain, total non-OPEC supply will move up 500,000 b/d to 41.7 million b/d in 1995.

Projected quarterly averages are 41.9 million b/d in the first quarter, 41.1 million b/d in the second, 41.4 million b/d in the third, and 42.2 million b/d in the fourth. This increase in non-OPEC supply is projected even though FSU output will drop 400,000 b/d to average 6.7 million b/d for 1995.

Non-OPEC total supply fell from 42.2 million b/d in 1990 to 40.5 million b/d in 1993, largely due to the decline in FSU output, which began in 1989. In that year, the FSU produced 12.2 million b/d; in 1993 it produced 7.8 million b/d.

Excluding the FSU and processing gains, non-OPEC production is projected to move up in 1995 to 33.5 million b/d from 32.6 million b/d last year. Non-OPEC output excluding the FSU averaged 30 million b/d in 1989.

The sharp increase in worldwide demand projected for 199,5 will be only partially filled from the increase in non-OPEC supply. There will also be an increase in demand for OPEC crude oil.

OGJ estimates that the call on OPEC crude oil and NGL will increase in 1995 to 28 million b/d from 27.1 million b/d last year. This will include 2.5 million b/d of NGL and 25.5 million b/d of crude production. This is up from NGL output of 2.3 million b/d and crude oil production of 24.8 million b/d in 1994.

OGJ anticipates an increase in stocks in 1995 to support the increase in product demand.

Demand for OPEC oil will again be related to events in the FSU. Consumption and production in the FSU will both decline in 1995; the question is which falls more. A production drop larger than the consumption decline would reduce FSU exports and make more room in the market for OPEC oil.

IEA data imply a stock reduction of 200,000 b/d in the fourth quarter of 1994 after a stock build of 1.1 million b/d during the second and third quarters.

OGJ projects a worldwide stock reduction of I million b/d during the first quarter of 1995, but demand will be up significantly. As a result, first-quarter demand for OPEC crude oil will move up to 24.9 million b/d. Seasonal worldwide demand will fall in the second quarter, but demand for OPEC crude oil will increase to 25 million b/d.

Non-OPEC supply is projected to fall 800,000 b/d in the second quarter as OECD Europe and North American outputs are reduced due to seasonal maintenance downtime in the North Sea and Alaska. And OGJ is projecting a I million b/d increase in stocks.

Demand for OPEC crude will increase to 25.5 million b/d in the third quarter and 26.4 million b/d in the fourth quarter of 1995. The increases will be required to meet the projected increase in demand.

If additional oil is available in 1995 from Iraq or other producers, production will have to be cut elsewhere, either as a deliberate act by OPEC or in response to falling prices.

PRICES

Crude oil prices started to move up during the second quarter last year as worldwide demand grew more than was anticipated. Prices moved even higher in the late second quarter and into the third quarter. Crude prices started to slip in September but firmed in October and November as demand stayed strong.

Crude oil prices had been stable since the end of the Persian Gulf conflict in January 1991. Prices fell sharply lately following the start of the war and then fluctuated in a range of $15-20/bbl. The range has drifted lower during the past 2 years.

The average price of world export crude oil started 1994 averaging $13.48/bbl in January, slipped to $13.19/bbl in March and rebounded to an average of $16.97/bbl in July. Crude prices slipped to $15.60/bbl in September and rebounded to $16.71 /bbl in November, before slipping again to an estimated $15.93/bbl in December.

The crude oil price during 1995 will depend greatly on how strongly economies recover and thereby raise demand.Among supply considerations, the FSU remains an unpredictable but important variable.

Recent additions to production capacity, especially among major OPEC producers, can offset likely declines in FSU output.

INTERNATIONAL DRILLING

The level of international exploration and drilling activity in 1995 will depend on crude oil prices.

New opportunities for exploration and production agreements have developed. Many countries with excellent production potential are in need of investment capital and technical assistance.

In addition, new technologies have greatly improved the efficiencies of exploration and drilling. This has two opposing influences on the level of activity. On the one hand, companies do not have to drill as many wells as they did before to meet their objectives. On the other hand, reduced costs make wells economic at given crude prices that would not have been before.

The Baker Hughes international count of active rotary rigs, which covers areas outside of the U.S. and Canada, averaged 734 for the first 11 months of 1994. The annual average was 773 active rigs in 1993, 857 in 1992, 909 in 1991, 907 in 1990, and 922 in 1989.

The number of active international rigs moved up slightly toward the end of last year, increasing to 735 in November from 709 in August. That may be a sign that the downward trend is about to change directions, especially if demand gains are sufficient to raise crude prices.

No end is in sight for the trend away from the U.S. for exploration and production spending, although major international companies have been increasingly selective about international opportunities in the past couple of years.

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