Frederick P. Leuffer, CFA - Integrated Oil
July 3 is an important day for oil: OPEC meets and the current phase of Iraq’s oil-for-food program expires. Nearly all OPEC ministers have indicated their intention to leave production quotas unchanged, at 24.2 million b/d. The quota does not include Iraq. If smart sanctions are put on the back burner and the oil-for-food program is extended for another six months, as some members of the UN Security Council espouse, then Iraq could begin exporting up to two million b/d of oil sometime next week. If Iraq does not resume exports, then we believe the rest of OPEC will increase production by cheating on quotas. It is important for OPEC to put on a good face, if it wants to avert a further decline in oil prices. However, as Saudi Arabia and others have stated, they will raise production to make up for lost volumes if Iraq stays out of the market.
This could be a major problem for oil prices when Iraqi exports resume. The debate in the UN over what to do with Iraq appears to be at a standstill. Our bet is that the U.S. softens its stance and backs a six-month extension. We believe the loss of Iraqi exports is the only thing that has prevented oil from dropping to $20/bbl or lower. Crude inventories in the U.S., as reported by the American Petroleum Institute stand at 313.5 million bbls, a level that in the past has been consistent with prices in the $18-$20/bbl range. Assuming that Iraq produces at the same level it did in May (2.9 million b/d), and OPEC holds production flat with May volumes, the total 27.6 million b/d would exceed our estimate of the call on OPEC oil by about 800,000 b/d. Under this scenario, the downward pressure on oil prices would build. If Iraq does not resume exports in the next few weeks, OPEC would see a gap between supply and demand of some 1.2 million b/d (by our estimate) that needs to be filled. As we have stated repeatedly, the fundamentals do not support oil prices in the mid-$20s/bbl or higher. The surge in oil prices to above $37/bbl last year is reflective of abrupt inventory corrections, and Saudi Arabia’s preference for high price volatility, and not a secular trend toward higher sustained prices, in our view. Oil price volatility has increased and is expected to stay high. Oil stock prices have corrected in recent weeks along with oil, refined product, and natural gas prices. However, we remain negative on the major oils and independent refiners as a group. Based on our published projected price ranges, we estimate the international integrated oils pose just under 20% risk, the domestics pose just over 20% risk, and the refiners pose about 27% risk. In our view, better buying opportunities in this sector lie ahead. |
