Weak fundamentals and skepticism in the market on OPEC’s ability — rather — resolve to implement the announced 1.2 million bpd output cut are issues that continue to plague the global crude markets, despite notable developments and announcements.
Secondly the fact remains that it might take at least four weeks for any output cut to have its impact on market. For all the crude on seas shipped before the output cut announcement, would still be filling the tanks of the consuming nations for a few more weeks.
Oil markets have undergone a sea change over the last few weeks. Indicators are pointing to a significant weakening of market fundamentals. The continued OPEC output for months has finally made the market psychology to register a completely different sentiment.
After months of producing almost at seams, it was becoming increasingly evident in the recent weeks that OPEC will have to change its course. The only variable was when? The moment has finally arrived.
In recent years, oil prices have continued to rise despite increasing inventory cover, but lately it was getting apparent that the covering was reaching a point that was putting downward pressure on crude market prices. Global stock cover had in the meantime risen from 70 days’ worth of forward consumption in 1Q05 to over 74 days in 3Q06 — a level where the markets felt considerably at ease.
Higher market prices over the last few quarters were also now starting to impact the demand growth in the US and elsewhere in the world. Oil demand growth has been slowing up noticeably in the three quarters of the current year. Thus far the global crude consumption has been rising year on year at a rate of 0.8 percent versus 1.7 percent over the equivalent three quarters last year.
Demand growth has in fact slowed sharply in all areas except China. Even sales of gasoline and diesel, for which there is no readily available substitute have risen just by a mere 0.1 percent this year in the developed world, while the consumption of naptha and burning fuels is down sharply as cheaper natural gas and coal appear making inroads into oil market’s share.
The incremental oil consumption in the key US market has also been languishing at a mere 120,000 bpd during the first nine months of 2006. In fact the International Energy Agency trimmed its 2007 global oil demand growth forecast by 90,000 barrels per day to 1.45 million bpd because of the weakening demand in the key US market. This change in the IEA’s monthly report follows a downward revision of 100,000 bpd last month too.
The US distillate output is also now being reported at new high and consequently the refiners are now cutting runs. Crude runs in Asia during July and August were 700,000 bpd higher than the same period last year and the US throughputs last month averaged 15.8 million barrels per day — a record for September. The surge in refinery output far outstripped consumer demand and product stocks have built rapidly in all regions. A consequent 25 million barrel stock build up last month took US inventories to an eight-year high of 760 million barrels.
Major Asian destinations too have also been facing product surpluses as local demand failed to absorb higher refinery output over the summer resulting in slashing of crude runs in Japan and some other Asian markets.
In Europe and China, though the situation was somewhat different as they represented bright spots in the otherwise gloomy market conditions, one has to concede. However, counterbalancing strength, the Atlantic Basin crude demand was reportedly slackening again, threatening further price falls.
The other factor impinging heavily on the market was market’s skepticism towards the OPEC decision to slash output. Despite the decision of Saudi Arabia and the UAE to trim their outputs as per the Doha accord, markets remained skeptic. Saudi Arabia told some of its major customers in Asia and the United States, on Monday, despite being the Eid day in the Kingdom, that it was slashing shipments to them.
Then the UAE also followed with similar announcements. Abu Dhabi’s state oil firm told major customers on Tuesday it would cut crude exports by about 5 percent in November, indicating its compliance with the OPEC decision.
However, markets still doubted all OPEC members would follow and this skepticism kept haunting the markets. Keeping in view OPEC’s past history, there were reasons for that skepticism.
Analysts here in Dhahran, the virtual global energy capital, strongly feel it would stay so, unless could prove that it was serious when the output cut decision was announced and that all the OPEC members were ready to shoulder the burden.
Markets needed evidence of OPEC’s seriousness in this regard. For in the words of the Monthly Oil report of the London based Center for Global Energy Studies (CGES), released on 23rd of the month, “had OPEC continued merrily to produce at current levels until the end of June 2007 an average OPEC basket price below $50 a barrel could easily have been on the cards for 1Q07 and a price under $40 a barrel would have been quite possible for 2Q07.”
The writing was very much on the wall! And hence the flurry in Doha, Riyadh and elsewhere in the oil capitals of the world.
The ride ahead could still be bumpy, one cannot write that off, yet if the OPEC could stick to its guns, things would indeed be different. The current market gloom would then be gone every one here concedes and admits.