Here is some more mindless reading:
Market Hotline
December 31, 1997
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Oil markets overreacting again, depressing oil prices
Oil markets have again overreacted to developments in OPEC and Iraq,
sending oil prices plunging to their lowest level in almost 2 years.
Nymex crude this week broke the crucial $18/bbl level, considered
something of a threshold for E&P spending and a harbinger of grim times
in the oil industry. However, it must be remembered that $18/bbl "ain't
what it used to be." These days, companies setting capital and
exploration spending plans tend to look at $15/bbl or lower for Nymex or
WTI as a threshold for drastically slashing budgets. And that's a
sustained price of $15/bbl, not just a day's settle on the Nymex.
Contributing to what has become a $4/bbl drop in oil prices since
November were reports that Iraq's return to world markets was imminent
and that OPEC's new quotas would take effect tomorrow.
Those two developments are the crux of the overreaction. True, the U.N.
reports that it expects to approve a new aid distribution plan based on
sales of Iraqi oil by the end of this week. It might take anywhere from
a few days to a few weeks for the resumed Iraqi oil exports to hit world
markets again. But we can count on Saddam to be unpredictable, and the
start of the Ramadan holiday looks to be a perfect opportunity for him
to pull another stunt with the U.N. weapons inspection program, because
that allows him 4 days without scrutiny by the inspection team. Then
watch the Clinton administration try to retaliate on the diplomatic
front (being too cowed to opt for a military option other than
ineffectual saber-rattling). That likely would entail something to slow
down or hobble the oil-for-aid sales program, which in turn would get
Saddam's ire up again. Then Baghdad would balk at proceeding with oil
sales, putting upward pressure on oil prices at just the time another
spell of cold weather ratchets up demand. The risk here, of course, is
in overestimating whatever grit-if any-that the Clinton administration
has. And that remains a risk.
On the OPEC front, of course, as always, it comes down to Saudi Arabia,
which is in a position to increase its oil production for the first time
in 4 years. If Saudi Arabia produces up to its new quota, together with
the stepped-up Iraqi oil exports, then OPEC production likely will hit
an 18-year high in first quarter 1998 of more than 28 million b/d.
That's what oil traders are looking at, coming at a time when fears of
the Asian economic downturn worsening and spreading could crimp demand
sharply.
It's still a big if. Officially, Saudi Arabia says it is confident that
oil prices will recover soon, and that increased demand in 1998 will
soak up the extra OPEC production. But while Saudi Oil Minister Ali
al-Naimi expects the kingdom to be able to produce at the quota without
contributing to a global supply oil glut, he also has said that Saudi
Arabia has no wish to send oil prices into a downward spiral: "Saudi
Arabia will not produce more than what the market needs. We are not out
to dump our crudes on tankers and sell them at whatever prices."
This is an absolutely critical insight, if sincere (and it almost
certainly is). It also sends a signal (that markets apparently missed
this week) that Saudi Arabia is again settling into a de facto mode as
swing supplier for OPEC, despite its many earlier claims that it would
not do so.
Despite its discomfort with this situation, Saudi Arabia can handle it
provided the other members of OPEC and non-OPEC producers aren't able to
grossly take advantage of the situation. And there is simply is not the
scope, currently, for other producers to snare that much more market
share from the Saudis. Al-Naimi has, in effect, said, "We will not
sacrifice oil prices for the sake of losing a little market share."
Let Saddam perform whatever mischief he will. That's the sort of thing
that causes the day-to-day gyrations in oil futures markets that don't
really count for much in the larger scheme of things.
For the longer term, watch closely how Saudi Arabia fine tunes its
output in the first quarter in response to supply/demand fundamentals,
including whether or not Iraqi oil exports start up again. If Iraq is
back on line, demand is sluggish, and the Saudis continue to produce at
their 8.76 million b/d quota throughout the quarter, then it's time to
reassess the situation. That would mean the Saudis are setting the stage
for another market share grab, at least a short-term one, and thus a
$15/bbl Nymex price is very much feasible, and the recent upturn in oil
industry fortunes will head south again.
It's more likely that Saudi Arabia will continue to produce less than
its new quota but more it had been, and then put much of that into
floating storage. Because the markets slavishly follow production levels
and their own speculation more than the physical supplies that actually
enter the market, that will keep some downward pressure on prices-unless
the lack of Iraqi exports and the onset of severely cold weather dictate
otherwise-that will put some downward pressure on oil prices until the
start of the spring/summer driving season. But it will still mean a
precarious physical balance, and it won't take much to boost prices
again, especially with another crisis.
Overall, absent a prolonged crisis, it's looking like oil prices might
average $18-20/bbl (Nymex) for much of the year. That's considerably
less than the $20-22/bbl seen for much of the past year, but it's hardly
a bust. It might be enough to squeeze a little out of E&P budgets later
this, thus forestalling some more supplies; it might be enough to help
the tottering Asian economies back on their feet later in the year, thus
bolstering demand again.
And that might be just what the Saudis have in mind.
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The OGJ Online Market Hotline provides an exclusive weekly snapshot of
selected oil and gas market activity, trends, and forecasts as a service
to OGJ Online Subscribers. Graphs accompanying the text in OGJ Online
Market Hotline feature, at a glance, the latest trends for the key crude
oil, natural gas, and refined products prices. Prepared by Bob Williams,
Oil & Gas Journal Managing Editor--News, OGJ Online Market Hotline is a
regular feature updated every Wednesday.
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