With crude hitting $80-plus zone, its direction remains a major puzzle before the energy analysts all around. And in this perspective, the impact of the OPEC decision to increase output ceiling on the market is still being pondered around.
There seems to be a mystery behind what is driving the crude markets to new heights. Few are able to unravel the mystery behind this surge. Real short-term factors appear to be resonating behind. Significant drop in crude inventories, a reported shutdown of nearly 200,000 barrels from Alaska’s North Slope — a fourth of the region’s total output and a gathering storm in the Atlantic being a hurricane season too — are to be noted.
Interestingly, global crude inventories though declining are yet above average for this time of year. The US has seen a string of weak economic numbers over the last several weeks. And the summer driving season in the US has also come to end. Hence the rise of oil prices to eight times what they were in the late 1990s remains baffling and — mysterious — as some say.
A deep look into the industry fundamentals reveals the true picture. In its weekly inventory report last week, the US Energy Information Administration said its crude stocks plunged by 7.1 million barrels. And despite staying at average levels, these were below last year. And with the winter heating season approaching fast, crude demand by refiners is bound to stay firm in the months ahead. Crude market pricing is definitely taking into account all these factors.
Another factor pushing up crude prices was renewed confidence in the economy as markets have relatively stabilized after August’s subprime-induced roller coaster in the US.
The demand-supply balance is hence tight, further magnifying the effects of geopolitical events, as there is less extra oil to cover demand if supplies get disrupted. The belligerent statement from the French foreign minister on Iran has also not helped soothe the crude markets.
The declining value of the US dollar, which oil is priced in, is also putting upward pressure on oil prices. And this becomes more pronounced when speculators are in the fray too, driving up the oil markets further. This year alone, an estimated $100 billion was put into commodities funds by everyone, from hedge funds to state pension plans.
The impact of the OPEC decision to lift output is though yet to be seen. The London-based Center for Global Energy Studies continues to appear apprehensive and skeptical, arguing in its September Monthly Oil Report (MOR) that “the discounts against benchmark crude grades for heavy, sour Middle Eastern crude oil (that OPEC has been putting on table) have not been sufficiently wide to make these grades attractive to owners of simple, hydroskimming refineries, but it is precisely some of these refineries that make up the world’s spare processing capacity.” The MOR then goes on to argue that “this means (for the OPEC) either producing more light oil or increasing significantly the discounts for heavy grades when setting price formulas for the coming months.”
There are also voices now that the additional OPEC crude to be made available from November would not make much impact in the shorter term, as this crude would reach the markets only beginning 2008.
In line with some other market pundits, the CGES also feels that at least in the short term the prices are heading toward new peaks. “The promised increase in output will do nothing to slow the rise in oil prices until at least the middle of next year, by which time they could be well on their way to $100/b.” Goldman Sachs has also lifted its crude price projection to $85 a barrel by the end of the year, saying crude could climb as high as $90 due to tight supplies. Their estimate was $13 higher than its previous forecast.
Goldman said OPEC’s decision last week to boost output by 500,000 barrels per day was not enough to mute bullish sentiment. “We believe that this will be too little, too late ... and now expect inventories to draw to critical levels this winter,” it said in a report.
Goldman forecast prices to rise as high as $95 by the end of next year.
However, in the longer term, prospects are not that rosy — at least from a producers’ perspective. The CGES maintains that “it is looking more likely that the current financial troubles that were spawned in the US subprime mortgage market may yet infect the ‘real’ economy and lead to a loss of confidence among US consumers, triggering a slowdown in the US economy and a consequent contraction in China’s exports. A fall in the volume of trade would undermine Chinese investment, the other pillar of its economic growth, and could lead to a dramatic slowdown in the main powerhouse of world oil demand growth.”
The CGES thus suggests that in the short term, oil prices may continue to rise despite the 0.5 million bpd of additional OPEC oil. In case of oil demand growth of 1.4 percent in 2007, with strong non-OPEC output, strengthening slightly to 1.6 percent in 2008 as per the OPEC demand forecast, the CGES feels that the price of dated Brent would continue its upward path, “averaging $94.5/b in the second quarter of 2008, before easing back to $78/b in the final quarter of the year.”
Before this could happen, though, the CGES projects that “oil demand growth would collapse, bringing prices back down with a bump.”
And this is what the OPEC is extremely concerned with. While addressing the OPEC ministerial meeting, when the Algerian Oil Minister Chakib Khelil reminded OPEC of Jakarta in 1997 during immense global pressure, OPEC decided to boost output just before the Asian economic melt down. This led to a crude price slump to $10 a barrel. Many others in the room in Vienna felt the same way too.
The oil markets are in for a bumpy, topsy-turvy ride over the next 12 months, with immense ramifications for this region — that depends largely on crude sales to maintain the current level of living standard of its population.
