The Oil Outlook After Iraq Elections
Oxford Analytica, 02.08.05, 6:00 AM ET
Although oil prices have come off the peaks seen in October, they remain relatively high. Indeed, they no longer seem likely to drift toward a $30 average this year (see: "Oil Could Drift Toward $30"). On the eve of the Jan. 30 OPEC meeting, West Texas Intermediate (WTI) reached an eight-week high close to $50 per barrel. The reasons?
Demand is still high. Despite predictions to the contrary, China's demand for oil shows no signs of slowing. Early downward revisions of demand for 2005 are now being reversed.
In addition to the technical problems that are slowing oil production in Iraq, export facilities also face the threat of attack.
And supply is an issue. The continuing Yukos crisis in Russia--a key non-OPEC supplier--is one factor that caused fourth-quarter production to be weaker than expected. The loss of Yuganskneftegaz has dramatically lowered Yukos' production capacity, eliminated spare crude for export and channelled all available crude to refineries for domestic customers. Production in January showed the fourth consecutive monthly fall and, for February, it appears that Transneft (the Russian pipeline monopoly) has allocated no export capacity for Yukos affiliates (past and present).
Also, OPEC's price objectives have also become clearer since December. The cartel, believing higher prices have not harmed global economic growth, will defend a higher price. At the Jan. 30 meeting, it announced the "suspension" of price bands created in 1999. The new official target remains unknown, but a consensus is growing that the floor will be $35 per barrel. The view going into the OPEC meeting was that the market might be oversupplied, leading to inventory rises in the traditionally weak second quarter. However, members decided to be cautious and leave existing production levels unchanged, adding exhortations to maintain quota discipline and signalling, if this did lead to price weakness, that they would quickly meet to cut production, even before the next scheduled meeting in Iran on March 16.
The market looks likely to continue to be tight, although perhaps not as tight as in 2004. However, the outlook is still one of fragility: The loss of any major exporter such as Iraq for more than a couple of weeks would certainly trigger an oil price shock. The paper barrel markets will provide volatility, yet there is a growing view that the non-commercials operating in the paper barrel markets are developing a psychological band towards which prices will gravitate--possibly $35 per barrel.
The market balances suggest that OPEC is in a strong position to achieve whatever price target it wishes. The balances may require OPEC to cut output, but this should present few difficulties in a context where all are enjoying high prices thus reducing the incentive to cheat and risk weakening price. The OPEC basket may average between $35 to $40 dollars during 2005 ($40 to $45 dollars in WTI terms), reinforced by the fact that Saudi Arabia likely considers $35 a reasonable target.
Lack of a stable government and new constitution in Iraq has left energy resources scarce for many.
There is a strong possibility that as part of a review of the old price bands, OPEC will change the composition of its price basket to reflect more accurately the sort of crudes exported by the cartel. Since the OPEC basket consists of mainly light sweet crudes, it produces a price far above what most OPEC exporters actually receive. This was aggravated in 2005 by very large price differentials. Thus, in October/November there was over a $14.50 differential between WTI and Arabian Light.
With an estimated turnout of 49% to 52%, Iraqi elections were relatively successful. There was less violence than had been feared, and there was no major disruption to oil exports. However, hopes that this presages a new era for Iraq in which oil exports will flourish and recover are seriously misplaced, even though such a view contributed to a post-election fall in oil prices.
The elections raised the level of uncertainty regarding exports. The oil export facilities face problems from attacks (which may get worse) and from technical problems (which are clearly getting worse). Rumors of serious technical problems with the Northern Fields have been rife for many months. Production fell from 2.4 million barrels per day in October to 1.5 million b/d in December. At the end of January, problems with water injection meant that exports of Basrah Light for February would be cut from 1.6 b/d to 1.45 million b/d.
Improvements in the Iraqi oil sector are unlikely. Although some oil majors are showing interest in providing technical assistance, no serious investment will take place until there is a credible and recognized government with serious legislation in place to govern upstream oil agreements. This is a long way off given that the constitution will almost certainly not be ready by the mid-October deadline. Similarly, violence against oil installations will continue, perpetrated by a combination of Sunni dissidents and foreign jihadists, who understand that these attacks are a way to damage a U.S.-backed administration.
If this were not enough, there are also concerns that an attack on Iran by U.S./Israeli forces could disrupt supply, not least if Iran retaliates with some form of embargo. Even if Iraq surprises on the upside, U.S. objectives in the region more broadly should ensure a strong geopolitical "floor" in the oil price.
Hopes that the elections will start the rehabilitation of the Iraqi oil sector are misplaced. The future is more likely to see less exports rather than more, certainly for this year and probably much longer. Given the naiveté of the market's optimistic reaction to the election, a serious setback for oil exports could produce a disproportionate backlash leading to a sharp increase in oil prices. Even in the best scenario, oil prices this year look like averaging $35 to $40 dollars per barrel for the OPEC Basket ($40 to $45 dollars for WTI).
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Why do you think they are a joke? Looks like they are doing a great job at managing world oil prices.
These guys were a joke in the late 90's, but this time its different (i.e. world oil demand is high and continues to increase, and WTI has been over $42 for > 6 months without a significant impact to the US economy). |
