The Middle East crisis has spawned a cottage industry in scenario development among oil industry analysts.
In the weeks following Iraq's invasion and takeover of Kuwait, analysts have put forth scenarios including an Iraqi pullout, a continuing stalemate, a coup against Iraqi President Saddam Hussein, a limited military engagement, and all out war in the Persian Gulf.
For each scenario, they estimated the price of oil resulting from those hypothetical events (Table). Some speculated on potential for more drilling, refining prospects, outlook for natural gas, and effects to the world economy under a spectrum of price forecasts.
Generally, analysts expect oil prices to settle back to preinvasion levels of about $20/bbl if Iraq withdraws peacefully from Kuwait, although some think the crisis has already created a permanent new floor price higher than before the crisis.
In general, analysts see oil prices skyrocketing to $5080/bbl in the event of all out war in the Persian Gulf. Many of the analysts predicted oil prices at $30-40/bbl in the event of limited military conflict. Those predictions mostly were made before last week's runup in U.S. crude futures to almost $40/bbl in part caused by war jitters.
None of the analysts seem to think the Middle East or oil markets will ever be the same, mainly because of the unprecedented nature of Iraq's annexation and sacking of Kuwait and Saddam's perceived threat to international interests.
Most analysts concurred that the longer the Middle East stalemate-resulting from a comprehensive embargo of Iraqi/Kuwaiti trade, the international community's insistence on Saddam's retreat, and Saddam's equally vehement vow to stay and fight-continues, the longer oil prices will remain high.
The upshot seems to be that those in the oil market forecasting business are close to consensus on one thing: there are unlikely to be any easy, quick fix solutions to the crisis that don't carry a high cost. And that in turn means higher oil prices for the foreseeable future than anyone had dreamed possible a few months ago.
MERRILL-LYNCH
Some analysts think the crisis will be relatively short lived because Saddam has badly miscalculated in gauging world reaction to Iraq's takeover of Kuwait.
Unlike previous Middle East crises, says Merrill Lynch, New York, the current situation has major Arab oil suppliers pitted against each other rather than bonded as allies. Iraq's oil producing neighbors are now enemies that do not support its oil policies or its military and political adventures.
"Iraq has been completely isolated by the international community," Merrill Lynch said, "And it hardly has any friends to support its military, political, or oil objectives."
Looking at Saddam not budging and the prospect of international solidarity arrayed against Saddam later weakening, Merrill Lynch expects a relatively short term military solution to the crisis with little damage to Saudi productive capacity and hence a resulting balance in supply/demand afterward.
Thus it believes the present situation will not last long and world oil prices will return to slightly above precrisis levels "sooner rather than later."
PRUDENTIAL-BACHE
Frank P. Knuettel of Prudential-Bache Securities Inc., New York, expects no oil supply shortages in his forecast for 1990-91.
Knuettel said combined production increases from Organization of Petroleum Exporting Countries and non-OPEC producers can offset 3.7 million b/d of the total 4 million b/d lost from Kuwait and Iraq. The remaining 300,000 b/d shortfall will be offset by lowered demand, he said. Knuettel thinks switching to gas will continue to cut into U.S. oil demand and Soviet output will increase more rapidly than expected. Also, more capital will flow to OPEC nations to build productive capacity, he said.
Knuettel's forecast of an average spot price for West Texas intermediate (WTI) crude at $21.10/bbl in 1990 and $22.25/bbl in 1991 assumes gradual settlement of the crisis along with drawdown of stocks and increased supplies from other OPEC producers. Without a military or political solution to the invasion by yearend, 1990 prices will likely be higher, Knuettel said.
PURVIN & GERTZ, C.J. LAWRENCE
Purvin & Gertz Inc., New York, expects the crisis to be resolved by yearend.
With demand depressed by higher oil prices and OPEC output climbing to about 23 million b/d, crude supply shortfalls are not likely in the fourth quarter, P&G said. P&G sees a firmer market through 1991, regardless of the crisis outcome, because of a likely new attitude toward OPEC quota adherence after the crisis.
Charles T. Maxwell of C.J. Lawrence, Morgan Grenfell Inc., New York, lays odds at two out of three that the world can avoid a prolonged military conflict involving air, sea, or land forces. Under this outlook, Maxwell estimates the recent strong surge of crude prices is near its crest for the current cycle.
On the other hand, if that one-third chance of a shooting war comes about, Maxwell predicts the price of crude will soar to more than $40/bbl for several weeks. Should international forces establish superiority over the Iraqi army and Hussein's regime fall, and assuming Kuwaiti and Iraqi oil fields suffer no permanent damage, the price will plummet to near $20/bbl, Maxwell said.
EAST-WEST CENTER
With the massive buildup of U.S. and other foreign troops in the Persian Gulf, Fereidun Fesharaki of EastWest Center's Resource Systems Institute, Honolulu, believes, "It is almost too late for peace."
Fesharaki contends that if the current stalemate extends much longer, global condemnation of Hussein and support for the U.S. will erode, which will severely undermine U.S. allies like Egypt's President Mubarak.
"Saddam Hussein's peace offer to Iran and his linkage of withdrawal from Kuwait to Israeli withdrawal from the occupied territories are slowly changing the nature of the conflict," Fesharaki said.
"The instantaneous support for Saddam from poor Arabs in Jordan, Egypt, Sudan, and the PLO is an indication of how Iraq's blatant aggression against Kuwait is being forgotten in the euphoria of praise for Iraq for standing up to the U.S. and the so-called U.S. puppets."
Fesharaki contends a long stalemate will affect international resolve against Iraq to Saddam's benefit.
"Higher oil prices over several months will make western/Japanese solidarity questionable. With U.S. allies seeing a major negative impact on their economies as a result of their own actions, the embargo will not last. Furthermore, the economic impact in the U.S. will begin to bite and weaken the U.S. resolve. Meanwhile, the economic embargo of Iraq will make life difficult but not intolerable for the people. Hardship may indeed strengthen the Iraqi people's resolve to back a leader many despise. The embargo can be tolerated 6 months or even longer.
"Time is on Saddam Hussein's side, not on the U.S. side. The longer the crisis continues, the tougher it will be to get out of it, and the stronger will be the possibility of Saddam surviving."
MEL CONANT
Melvin A. Conant, writing in his Washington newsletter Geopolitics of Energy, spells out five likely outcomes of the crisis the next 6 months:
- Preparations for war will continue without a outbreak of shooting. Embargoes on Iraqi and Kuwaiti oil remain effective, asset freezes stay in place, and most embargo losses are made up by other producers.
- U.S. led international forces strike Iraqi military targets, and Hussein retaliates, damaging Saudi terminals, which cuts Persian Gulf exports by another 2 million b/d for 3 months. Then an armistice is reached, and Iraqi/Kuwaiti exports resume after a 30 day delay.
- Iraq could invade Jordan, bringing Israel into the fight and forcing the U.S. to come to Israel's defense. This would crumble Arab opposition to Hussein, resulting in more lost oil supplies.
- Iraq could launch successful strikes at Yanbu and Ras Tanura terminals, cutting Saudi exports by 4 million b/d for several months. After retaliation by U.S. forces, Iraq asks for and gets an armistice, and oil embargoes are lifted.
- Hussein is assassinated, and his successor asks for and receives U.N. sponsored intervention. Oil and trade embargoes are lifted, full Iraqi and Kuwaiti production comes back on stream.
In any scenario, use of strategic oil reserves may be necessary, Conant contends.
"Should oil prices remain at $40/bbl or above for more than 30 days, severe impact on world economies could lead to an OECD led agreement between key importers and Saudi Arabia, Venezuela, Indonesia, and Nigeria for a ratcheting down of oil prices to $30/bbl," Conant wrote.
No matter how the crisis is resolved, once that occurs, oil prices will remain volatile but fall to $20-25/bbl because of widespread overproduction, according to Conant.
"The complexity of postarmistice settlements is evident from this partial list of outstanding issues: freedom for Kuwait, large scale demobilization of Iraqi forces, U.N. supervised demilitarized zones between Iraq on the one hand and Kuwait, Jordan, and Saudi Arabia on the other, U.N. general embargo on weapons for Iraq, payments by Kuwait-already agreed to-for oil removed from Rumaila field, long term lease of Bubiyan and Warbah islands by Kuwait to Iraq, question of compensation by Iraq for costs incurred by Kuwait, Saudi Arabia, and possibly others, question of continuing U.S. and other forces' presence in Saudi Arabia or in the gulf, and complications from restoration of the rule of the emir in Kuwait," Conant wrote.
SHEARSON LEHMAN
Simon Trimble, Shearson Lehman Bros., New York, has concluded there is little chance of a return to the low oil prices of second quarter 1990.
What is more likely is a new floor price for WTI of $24/bbl in 1991, Trimble said. If Iraq backs down and returns to its original border, Trimble says, OPEC should be able to stay within its production target of 22.5 million b/d and keep its marker at about $21/bbl, or $24/bbl for WTI.
He gives this outcome a 10% chance.
Trimble gives a 40% chance to maintaining a successful blockade of Iraqi/Kuwaiti oil exports, resulting in WTI at $27/bbl in fourth quarter 1990 and early 1991.
Trimble put a 20% chance on Saudi Arabia holding to its OPEC quota of 5.3 million b/d, resulting in WTI staying at $30/bbl. His forecast came before the Saudis ramped up oil production to more than 7.5 million b/d last month (OGJ, Sept. 10, p. 24).
Should open hostilities break out, with Iraq striking Saudi fields and U.S. forces destroying much Iraqi production, Kuwait's oil fields could also be severely damaged or destroyed in the crossfire. Such an event, with a 30% chance, would send WTI to $47/bbl, said the Shearson analyst.
SRI, MABON, NUGENT
Stanford Field, director of energy programs at SRI International, Menlo Park, Calif., sees WTI at $30-40/bbl during winter.
Prices in that range will provide the incentive for the U.S., Japan, and Germany to draw on their strategic petroleum reserves (see Watching Washington, p. 37). He expects the required drawdown rate in fourth quarter 1990 and first quarter 1991 to be 1.4 million b/d for the U.S., 300,000 b/d for Japan, and 200,000 b/d for Germany
The use of these reserves at fair prices will help prevent a "buckling of economic activity." Failure to make use of SPRS, either because of bureaucratic delay or political squabbling, will hasten the impending economic downturn, Field believes.
As spring 1991 nears, winter heating demand will ease, gas switching will increase, and economic activity will slow down, all contributing to a decline in oil demand and subsiding of oil prices toward their long term underlying trend, Field contends.
Daniel F.D. McKinley of Mabon, Nugent & Co., New York, sees the possibility of a U.S. "knockout punch" of Iraq that could still preserve world oil production capacity.
At risk, however, is lost oil production in Saudia Arabia, McKinley noted. Kuwaiti oil fields are already mined, and Iraq's fields are believed vital in the medium term. Accidental flareup or a failed knockout attempt would put about 35% of the world's productive capacity and two thirds of its reserves at risk.
What McKinley describes as "the least unhappy alternative"-an Iraqi coup against Hussein-could be the only scenario in which prices recede to the low $20s/bbl, but only after "months if not years" of unrest.
LONDON FORECAST
DRI/McGraw Hill, London, Produced a series of price forecasts based on various scenarios in the Middle East.
Its base case assumes that Iraq remains in Kuwait and a total shutdown of the Iraqi and Kuwaiti oil industries continues. Expansion of production in the rest of the world combined with a third and fourth quarter stock draw limits the net loss.
If Iraq leaves Kuwait by January 1991 and OPEC production returns to prior levels by the second quarter, the average fourth quarter and first quarter 1991 price is $24/bbl, falling back to less than $20/bbl by mid-1991, DRI predicts.
In a second scenario, DRI sees a world oil supply shortfall of 1.5 million b/d developing in 1990-91 compared with preinvasion levels. By yearend 1991, Iraq!/Kuwaiti production returns to 50% of preinvasion levels and reaches 80% by yearend 1992. Under this case, world prices top $26/bbl by yearend 1990 in early 1991, slowly declining to $23/bbl by yearend 1991 and $20/bbl by yearend 1992.
In the event of a war in which all Saudi output is lost and other production and stockdraws can't offset that large loss of supply, DRI sees the average world oil price at $37/bbl in the third quarter, more than $48/bbl by the fourth quarter, falling to $45/bbl in first quarter 1991, and back down to $20/bbl by third quarter 1991.
This assumes that Iraq 'is defeated and withdraws from Saudi Arabia and Kuwait by November. Production facilities in all three countries are assumed to be damaged, but production returns to 50% of preinvasion levels by January 1991, 90% by April, and 100% by July.
REPERCUSSIONS
SRI's Field sees lower than normal economic activity from higher oil prices as the long term legacy of an ineffective embargo. If Hussein retreats or is overthrown, the net effect will be "only a perturbation on a weakening trend," he said.
If there is a limited military engagement, however, the resulting high oil prices will cause a major decline in economic activity, Field contends.
And if there is all out war, the recession becomes a major depression, he said.
But Shearson Lehman's Trimble believes the effect of oil costs on key economies as a percentage of gross national product has declined the past 20 years, meaning the U.S., European, and Japanese economies will suffer much less than in prior oil price spikes. Trimble adjusted the August price of $22/bbl for Dubai Fatah, a light crude traded the past 20 years, for the GNP deflator to reflect its value in 1989 money. That results in an oil price well below levels during much of the 1970's and 1980's.
He pointed out that oil prices soared by 400% in 1973-74 and 300% in 1979.
Although demand from the transportation sector will drop sharply, as it did after the 1979 price shock, it should rebound after about 3 years, Trimble contends. A sustained price hike of 30% "would have only a very modest and short term impact on world transportation fuel demand."
Economic fallout from an outbreak of war would result in a 700,000 b/d decline in 1991 world oil demand, he contends.
"This is not too bad given that oil prices would be at $47/bbl," Trimble said.
The downside, however, is that OPEC production is not likely to rebound quickly and prices would remain high for several years, until the world could replace lost capacity, he noted. Trimble sees a more probable outcome of $27/bbl, which would not shock the world market into cutting demand in 1991.
REFINING
The loss of Kuwait's mostly complex 750,000 b/d of refining capacity, is a critical issue in the crisis, contends Paul Mlotok, Morgan Stanley & Co., New York,
Further, Saudi Arabia is diverting products from export refineries at Yanbu and Jubail to supply military forces on the Arabian Peninsula, cutting open market supplies by another 200,000 b/d.
This nearly 1 million b/d cut in supplies of high quality products comes when global refining capacity is already running at a very high utilization rate.
By winter, says Mlotok, product supply may get very tight even if crude supplies are adequate,
Such a crunch will push the industry to its limits, possibly leading to accidents such as those recently in Baltimore, Houston, and Deer Park, Tex., Mlotok warns. adding that further retail price hikes would likely follow.
DRILLING
Crude price spikes will boost drilling budgets as well as spur spot gas prices to more than $2/Mcf by yearend, predicts James Carroll, PaineWebber Inc., New York.
Carroll expects heightened concern about global energy supplies along with increased seasonal demand for gas will result in "positive surprises" in second half drilling activity.
While 1990 drilling budgets were based on $16-18/bbl oil, it is likely that 1991 budgets will be based on $20/bbl, Carroll said. This change will accelerate the drilling cycle faster than originally thought.
It will also result in worldwide revenue growth of 20% for oil service companies vs. his earlier forecast of 15%. Carroll predicts the worldwide rig count will average 2,075 for 1990.
An embargo of Iraqi and Kuwaiti crude through 1992 will result in an average WTI spot price of $32.50/bbl the next 2 years, predicts Spears & Associates Inc., Tulsa.
If operators perceive the embargo will continue beyond 1990, the average U.S. rig count in the fourth quarter will increase to 1,080, Spears says. If the standoff persists through 1992, the U.S. rig count will average 1,105 rigs in 1991 and 1,270 in 1992.
If the crisis is resolved peacefully by yearend, Spears sees WTI spot prices averaging $21/bbl in 1991 and $22/bbl in 1992.
The average count of 1,000 U.S. active rigs Spears earlier projected for 1990 will remain unchanged with a peaceful resolution, followed by an average rig tally of 1,025 rigs in 1991 and 1,075 rigs in 1992.
War will drive the average spot price for WTI to $40/bbl through 1992, Spears predicts.
Spears predicts hostilities will increase the average U.S. rig count to 1,125 in fourth quarter 1990, 1,211 in 1991, and 1,360 in 1992.
GAS OUTLOOK
Vinod K. Dar, managing director of Dar & Co., Washington, believes average natural gas prices in 1991 still won't top $2/MMBTU on the Gulf Coast, even if crude prices stay at $30/bbl.
Some analysts predict $45/MMBTU at the wellhead, based on $30/bbl crude and an 8:1 ratio for oil prices relative to gas prices, he noted.
However, Dar contends that prospect is illogical. At that oil price, low sulfur resid will cost about $4/MMBTU on the East Coast. Subtracting an average charge of $1.25/MMBTU for total winter gas transportation from the wellhead on the Gulf Coast to fuel switchable industrial users in the Northeast U.S. results in a netback to the wellhead of $2.75/MMBTU. That would put the ratio closer to 11:1 with crude at $30/bbl.
Even in the unlikely event oil prices hold at that level for 2 years, the 11:1 ratio is not assured in 1991-92 because, "Gas will and must still compete with gas," Dar said.
If most of the few facilities with dual fuel capacity have already switched to gas because of its persistently low price relative to oil, that means there is very little unexploited switching capacity, Dar said. Accordingly, he wonders from where the increased demand will come.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.
