As OPEC ministers
arrive for the meeting on January 17, 2001, the issues are not as black
and white as they appear to the casual observer. Most news reports indicate
a consensus of a cut of about 1.5 million barrels per day and that is our
expectation as well. Let's look at the various segments of the problem.
OPEC is concerned about preventing
another price collapse. This concern is real. The outlook for the economy
of the major oil consumer, the United States, is uncertain. As the U.S.
is the driving force behind many of the economies of the rest of the world
we must add concern for the health of Europe and Asian economies as well.
An ill timed production increase
just as Asian economies were weakening led to the last price collapse.
To avoid the possibility of a repetition OPEC has adopted a price band
of $22 to $28 per barrel for the OPEC basket of crudes with "automatic"
adjustments of 500,000 barrels per day when the price is below $22 for
10 days or above $28 for 20 days. OPEC has also been meeting quarterly
to better manage the inherent volatility of crude oil prices. In practice
there have been few automatic adjustments as the timing for the adjustment
mechanism to go into effect has almost always coincided with an upcoming
meeting and adjustments were delayed until the meeting.
Underlying all OPEC decisions
is the fact that for most OPEC countries crude oil represents over 50 percent
of their export revenue and in some cases over half of the country's GDP.
To some extent even the internal political stability of many OPEC nations
is dependent upon maintaining or increasing petroleum revenue.
As we have noted
in the past, the demand for petroleum is seasonal. Demand within
OECD countries can vary 7 million barrels per day from the peak consumption
month in the winter to the summer low. This is a critical factor in OPEC's
upcoming deliberations especially with an uncertain outlook for world economies
and since a short term imbalance between supply and demand of a million
barrels per day can move prices $3 to $5 per barrel.
While demand is very seasonal
this is not as much the case with production. In
fact most years seasonal variation in world production is much less than
half that of consumption.
Why then do prices not fluctuate
by $15 - 20 per barrel every year if supply and demand are out of balance
by 3 -4 million barrels per day in some months? The balancing item is inventories.
Historically, consuming nations would build crude and product inventories
in preparation for the winter heating season.
Unfortunately for OPEC that
historical pattern of summer inventory build has been showing signs of
change. Refiners have been hesitant to build inventories for the winter
season in the past couple of years. The reason is best illustrated by looking
at the strip of futures prices on the right. While it is not as extreme
as it has been over the last year or two the current market exhibits considerable
backwardation. With a difference of $3 to $4 in expected crude prices between
today and three months from now a refiner faces the risk of being caught
with high cost product in inventory if they build stocks for sale several
months out. As a consequence most have gone to a just in time policy.
The just in time policy has
resulted in product inventories in the U.S. which are dangerously low.
(These inventories will discussed in detail in our next petroleum inventory
update.) The point is this unless OPEC takes an action which removes backwardation
from the market refiners will not rebuild inventories to normal levels
and OPEC faces the full brunt of the 7 million barrel per day fluctuation
in the seasonal demand of its largest consumers.
Light Sweet Crude
You can obtain this data in
close to real time at www.ino.com: Crude
If OPEC wants to sell more
crude it needs to remove backwardation from the market. The question is,
"Can OPEC flatten the forward curve?" The answer is a definite maybe. The
scenario with the best chance of success is one which narrows the $22 -
$28 per barrel price range and announces a phased cut in production over
the next few months. The cut could be as much as 1.5 million barrels effective
in February with an additional 1 - 2 million barrels over in March and
April. There would be an opportunity to adjust these numbers through the
price band mechanism or at the next ordinary meeting in March.
If OPEC were to narrow the
price band, political expediency on the home front would probably
result in a price band centered around $25 per barrel. Unfortunately for
OPEC nations this price band would likely come under threat within a year.
The last report had non OPEC production up by 700,000 barrels per day and
non OPEC production will continue to increase as long as prices remain
much above $20 per barrel. If these increases are accompanied by weaker
world economies OPEC will have to reduce its market share to maintain prices.
At some point OPEC will have to make the decision that it usually faces
twice a decade. It must choose price or market share, but it cannot have
both. A price than can be maintained with market chare is closer to $20
per barrel than to $25.
For a graphic OPEC overview
go to our OPEC and World Oil Graphs
What about the ability for
non OPEC nations to produce more oil? One of the best answers comes from
Shell. Take time to read The
Future of Global Exploration by Andy Wood, Head of Global Exploration,
Shell International E&P B.V.
by James L. Williams
James L. Williams
Phone: (501) 293-4081
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