OIL AND NATURAL GAS PRICING SCENE - PART 1
FEATURE-The Arab Embargo -- Oil Crisis To OPEC Crisis
A quarter of a century after the Arab oil embargo, the West's lingering nightmare that the petrol pumps might again run dry has scarcely felt so remote.
Awash with oil, the once-mighty OPEC cartel now suffers the lowest real crude prices since it tipped the world's leading industrial powers into crisis in 1973.
Saudi Arabia's King Faisal sanctioned the embargo on October 17 that year to punish the West for its support of Israel in the Arab-Israeli war that started on Yom Kippur, 11 days earlier.
Oil prices quadrupled, scarring the economies of the West for years with recession, inflation and unemployment.
The Organisation of Petroleum Exporting Countries ushered in the era of shared baths, power cuts and little stickers urging consumers to "save it".
At the height of the energy crisis in the winter of 1973, U.S. President Richard Nixon solemnly announced that the national Christmas tree would remain in darkness.
Twenty five years later, in the worst oil glut for a decade, it is OPEC that is feeling the backlash of the first oil shock.
This year's severe glut is only the latest in a series caused by persistent oil market overcapacity, partly a consequence of the 1973 embargo.
Sheikh Zaki Yamani, the mastermind behind Saudi oil policy at the time, admits mistakes were made.
"I think we were intoxicated in the seventies and some major consumers helped us dig our grave," the former Saudi oil minister told a recent conference in London.
Vowing not to be caught out again, the West invested in its own oil.
The major companies, sent packing by the nationalisation which swept OPEC producers, invested heavily in regions like the North Sea. New technologies were invented to slash the cost of finding crude.
Power generators in nations without oil turned nuclear and then increasingly to cleaner fuels like natural gas.
Consumers also became more efficient. High taxes in most parts of the industrialised world, with the exception of the United States, have replaced high prices as the incentive for efficiency gains.
In Europe, tax now counts for more than 80 percent of the price of petrol. European motorists pay $185 a barrel at the pump for gasoline which fetches $17 a barrel at the refinery gate.
Oil demand growth this decade has been quelled to little more than two percent a year from seven percent annually in the 20 years before the 1973 embargo.
BIG OIL IS BEAUTIFUL AGAIN
Stagnating demand and this year's low prices have already started to reshape the structure of the oil industry.
Shell <RD.S><SHEL.L> chairman Mark Moody Stuart has predicted that oil prices, having averaged $18 a barrel over the past 10 years, could stay depressed at $12-$16 in the medium term.
"Financial instability has already taken a toll on the oil industry in terms of lower demand growth," warned Franco Bernabe, chief executive of Italian energy giant ENI <ENI.MI>.
The giant merger of British Petroleum <BP.L> and Amoco Corp <AN.N> is expected to spark further consolidation among companies keen to cut costs.
"Lower cost is the driving force for big oil," said analyst Fadel Gheit at Fahnestock and Co.
"It is a mature industry with slow or no growth. There is no question that we are at a turning point and oil companies can only merge."
Meanwhile, the big Gulf oil states are starting to welcome back the multinationals they shunned two decades ago. Even Saudi Arabia is showing signs that it might reopen the door to foreign investment in its prized oilfields.
"Repeated attempts to defend oil prices have cost the industry in the Gulf dearly in terms of future expansion and development," said Mehdi Varzi of Dresdner Kleinwort Benson.
Oil prices, controlled first by the multinationals and then by OPEC, have long since fallen under the spell of the market.
OPEC ministers, by the time of the second oil shock in 1979 in the aftermath of the Iranian revolution, were able to force prices to $41 a barrel.
Now the free market writes the rulebook and oil is back around $14. Flickering futures screens and financial derivatives dictate market direction.
"The interplay of commercial, political and economic forces has fundamentally altered," said Robert Priddle, executive director of the International Energy Agency, set up by the industrialised powers to safeguard energy security in the wake of the 1973 embargo.
"Market forces have overwhelmed the institutions which were created to manage them."
A FUTURE OIL SHOCK?
Past oil shocks were caused as much by the fundamentals of supply and demand as by the fear factor of politics.
Surplus supply capacity was negligible in the months before the 1973 embargo after years of soaring demand.
After this year's three million barrels a day of supply cuts, designed to bolster prices, spare capacity stands at more than five million barrels on the 75 million barrel a day market.
Nevertheless, few are prepared to rule out a future oil shock.
Prices soared briefly above $40 in 1990 when dealers thought Iraq's invasion of Kuwait might turn into missile strikes on Saudi oil facilities.
And the volatile Middle East remains home to 65 percent of the world's one trillion barrels of known oil reserves.
OPEC's 40 percent share of global production, down from two-thirds in the 1970s, will rise again once low prices start to squeeze out high-cost production.
"A new era of Middle East dominance in oil supply will come when North Sea production has peaked and before non-conventional oils are widely used," predicted the IEA's Priddle.
Geologists say that despite new sources such as the Caspian Sea and offshore West Africa, oil companies are losing the race to replace depleting reserves.
"Over the past decade, less than half the world's oil production has been replaced by new discoveries," Geneva based Petroconsultants says. "Over the past five years, the replacement ratio has dropped to just over 30 percent."
British academic Colin Campbell, in a study of what's left in the world's petroleum reservoirs, concludes that oil is nearing the point of terminal decline.
"We can be in no doubt," says Campbell, "that Hydrocarbon Man is approaching a turning point as conventional oil production reaches its peak within a matter of a few years."
Kuwait Says Oil Prices Could Rise Early In 1999
World oil prices could rise early in 1999 on the back of a drop in stocks, Kuwait's oil minister was quoted on Sunday as saying.
Sheikh Saud Nasser al-Sabah predicted in a written response to a parliamentary question that oil prices could rise as higher consumption during the winter season in the northern hemisphere depleted world stocks.
"Prices will probably stay at their current levels until the start of the winter season in the fourth quarter and the draw down on oil stocks...which could relatively contribute to an improvement in prices with the start of next year," he said in the response which was carried by al-Anba daily.
Sheikh Saud, who came to office in March, had earlier said prices could recover from recent 12-year lows by the end of the year.
He has led an initiative to push world prices towards $17 a barrel for international benchmark Brent. Sheikh Saud has also said that fellow OPEC states should be prepared for a third round of output cuts when they meet in November if prices failed to reach that level.
Brent closed on Friday just above $13 a barrel.
The minister put Kuwait's crude oil production cost at about $1 a barrel while refined products were produced at an average $15.93 a barrel during the last fiscal year, which ended in June.
He said crude production in 1997/98 cost between 260 and 300 fils a barrel. There are 1,000 fils to the dinar.
Projected oil revenues of 1.894 billion dinars ($6.31 billion) were calculated in the 1998/99 budget at an output of 1.98 million barrels per day, an exchange rate of 0.302 fils to the dollar and a production cost of 400 fils a barrel.
Sheikh Saud put the average price of oil during the last fiscal year at $16.87 a barrel.
It was not clear if the figure was for Kuwaiti export crudes which averaged around $11.37 in the first half of 1998 compared to an average $17.81 for the whole of 1997.
Kuwait export crudes are currently selling at between $10.23 and $12.16 a barrel.
With the sharp drop in world oil prices, Kuwait calculated its 1998/99 budget at $10 a barrel compared to $13 a barrel estimates used in previous fiscal years.
The 4.362 billion dinar budget for the year which started on July 1 carries a projected net deficit of 1.919 billion dinars and a gross deficit of 2.163 billion dinars. ($1 = 0.3 Kuwaiti dinar)
US GAO Asked To Investigate IEA World Oil Forecast
The U.S. General Accounting Office was asked on Friday to investigate the accuracy of the International Energy Agency's forecasts for world oil supply and demand, and whether those projections have unnecessarily helped push down crude prices.
Senator Pete Domenici (R-NM) wants the GAO to look into the IEA's 1997 and 1998 forecasts that there would be an oversupply of oil, which the senator claims is not as great as the organization predicted.
''I am told that the IEA is at a loss to explain what has happened to the forecasted oversupply and has termed this an 'arithmetic mystery','' the senator said in a letter to the GAO, which is the investigative arm of Congress.
Domenici said it is crucial that traders in the oil futures pits at the New York Mercantile Exchange have the most accurate information to ensure orderly trading.
The senator asked the GAO to find out how the IEA comes up with it oil supply and demand forecasts.
''Should the IEA be in the business of making oil supply and demand forecasts or should they focus solely on reporting inventory figures?'' Domenici asked.
The Independent Petroleum Association of America said it supported the request for a GAO study. The trade group said its analysis shows the IEA may be over-predicting worldwide crude production.
For example, the group pointed out that the IEA forecast that world supply would exceed demand by 3.4 million barrels per day (bpd) during the second quarter of 1998, but the IEA said that only 1.8 million bpd of excess oil showed up in inventories. That leaves 1.6 million barrels of oil per day missing.
''If IEA predictions are not accurate, and the magnitude of oversupply is much less, the market might very well have reacted in a different way in the last 11 months. Oil prices might not have seen their precipitous drop from where they were one year ago,'' the trade group said.
U.S. Refining Margin Revival Short-Lived -Analysts
Hurricane-induced refinery outages and seasonal maintenance shutdowns have bounced U.S. refining margins back into the black, but the revival is to be short-lived, industry analysts and traders said on Friday.
''Refining margins have improved primarily as a function of the strength in the prompt (products) market, but the numbers are misleading - the outer markets are not as attractive,'' said Tom Knight, a trader at energy company Fina Inc., a unit of Brussels based PetroFina SA (NYSE:FIN)
''It (the positive margin) should stay a little bit further...as long as the refineries are down. On the East Coast, the scheduled shutdowns will last till October or November,'' Knight added. ''The Gulf Coast is much more of a question mark - how long will the big refineries be down?'' Hurricane George hit the U.S. Gulf Coast on Sept. 28, closing down at least seven refineries in Louisiana and Mississippi.
Five of them escaped damage, but the precautionary shutdowns took out around a week's worth of 928,000 barrel-per-day (bpd) of production last week, traders said.
But what sent buyers scurrying into the Gulf Coast market, and pushed product prices and, subsequently, margins much higher along ''refinery row,'' which accounts for half of the country's output, was the longer lasting havoc the hurricane wrought at Chevron Corp.'s (NYSE:CHV) and British Petroleum Co. Plc's (quote from Yahoo! UK & Ireland: BP.L) plants.
After floods of up to four feet of water, Chevron's 295,000 bpd refinery at Pascagoula, Miss., still has no definite start- up date, with market speculation placing its restart between a month and the end of the year.
Although averting major damage by the hurricane, BP's 250,000 bpd Alliance refinery at Belle Chasse, La., was hit by a fire during its start-up. It has restarted its secondary units but its fire damaged crude unit will remain shut for another seven to 10 days for repairs.
As a result, U.S. Gulf Coast refiners have in the last 15 days seen returns for processing benchmark West Texas Intermediate crude turn positive, after slumping into the negative since August, according to Reuters' calculations, based on standard product yields.
Nationwide, refinery margins or profits last week edged up to $2.51 per barrel from the average return in September of $2.44, according to analyst Paul Ting at Salomon Smith Barney.
Jim Ritterbusch, president of Ritterbusch & Associates, in Chicago, said margins ''are not good and they are not bad. They are not bad enough to force run cuts, but they are not good enough to get anybody excited.''
Analyst Nizam Sharief at Hornsby and Co. noted that ''margins are not particularly healthy, compared to a year ago or six months ago.''
A surplus of oil products has eroded refining margins with the third quarter registering the lowest returns for the year at $2.95 per barrel, much lower than the $5.07-per-barrel margin during the same period last year, Salomon Smith Barney said.
''I see some margin deterioration, as refineries in turnaround come out of it,'' said Ritterbusch, referring to the East Coast turnarounds.
Two large turnarounds at Sun Co. Inc. (NYSE:SUN) and Tosco Corp. (NYSE:TOS) in the northeast, the biggest consuming region in the U.S., will take out some 287,000 bpd of crude processing or 7.6 million barrels of product output until late October.
Another big supplier of products to the northeast -- North Atlantic Refining Ltd -- will also shut down its 105,000 bpd refinery at Come-By-Chance in Newfoundland, Canada, during the second half of October for maintenance.
Gulf Coast traders were also bearish on the outlook.
''Inventories are too full,'' a Gulf Coast trader said. ''Refiners have been running the gasoline margins, and they all do it at the
same time.''
Hurricane hype had caused the crack, or the difference between the benchmark prompt gasoline contract on the New York Mercantile Exchange (NYMEX) and its crude feedstock, to soar by around $1.00 per barrel to $4.40 -- the best crack since mid-August.
But by Friday, cracks were paring most of their gains, trading around $3.70.
OPEC President Favors Output Cuts
OPEC President Obaid bin Saif Al-Nasseri said Sunday that it would be easier for the Organization of Petroleum Exporting Countries to agree to extend its previous production-cut pacts another six months than to implement another round of reductions.
At a press conference on the sidelines of the Middle East Gas Summit '98, Nasseri also said that OPEC must act to enable Iraq's full return to the world oil market.
Nasseri, who is also the United Arab Emirates oil minister, said it's ''difficult'' to predict prices and that oil producers from both OPEC and non-OPEC countries must hold consultations on what to do next.
''What will dictate that will be the level of prices and the level of demand,'' he said.
Asked whether prospects for another round of OPEC/non-OPEC cuts have dimmed because of statements by the Venezuelan oil minister that his country won't cut any more and by the Saudi oil minister that market share is his country's top priority, Nasseri said: ''Market share is important, but dumping more oil or excess oil onto the market won't be a wise idea.''
Saudi Arabia and Venezuela and non-OPEC Mexico formed the troika which launched the first production cuts in March. The three are in a fierce battle for U.S. market share. The Saudi and Venezuelan ministers emerged from a recent meeting in Cancun saying they would push for an extension of the current pact at OPEC's November meeting. Other OPEC members, such as the Kuwaitis and Iranians have been lobbying for another round of cuts.
Nasseri also reiterated that Gulf producers aren't willing to cut alone to improve prices.
''There's no point in a group of (oil-producing) countries doing something that the rest aren't willing to do,'' he said.
Nasseri said he hopes OPEC will reach a consensus in the next couple of months ''either on this or that'' about what to do next. ''OPEC always reaches a consensus,'' he said.
One factor ministers have noted wasn't taking into account at the last OPEC meeting in June was Iraqi output of 2.6 million barrels a day. In June, the organization estimated Iraq's production at 2.1 million barrels a day. While an OPEC member, Iraq's output is subject to the oil-for-food deal with the United Nations.
''The Iraqis had their share before sanctions and will be looking to return to that share of the market,'' he said. ''OPEC has to do something to enable Iraq to return to its old share.''
But the minister skirted a question about whether the United Arab Emirates would reduce its own output to allow the Iraqis back in. Following the 1990 invasion of Kuwait and the placement of sanctions on Iraq, other OPEC producers -- primarily Saudi Arabia and the United Arab Emirates -- boosted their own output to offset the crude shortfall. The move was supposed to be a temporary one pending Iraq's return to the market.
''It is natural that when the Iraqis stopped producing, other countries took their share,'' he said.
Oil Producers Cannot Afford More Cuts - Tellez
Mexico's energy minister, Luis Tellez, said on Friday that oil-producing countries cannot afford, politically or economically, to make any further oil production cuts.
''No further cuts are planned because they are not credible and because we (oil producers) cannot afford to do so politically or economically,'' Tellez told Reuters before speaking at a local university.
Mexico, together with Saudi Arabia and Venezuela, has led two rounds of production cuts this year, which have reduced OPEC output by nearly 2.5 million barrels per day, as well as securing further cuts from non-OPEC producers, such as Mexico. The cuts have stemmed, to some extent, the collapse in world oil prices but have not led to a sustained recovery.
In his speech, Tellez said he was encouraged by an International Energy Agency report on Thursday showing nearly full compliance among the producers that have pledged cuts, though he said he expects only a ''light recovery'' in oil prices over the next year because of the economic downturn that has gripped many industrial economies.
The Paris-based IEA, which is the energy watchdog for major oil consumers, on Thursday forecast that demand for oil would likely run ahead of supply over the next two quarters, though that would drop off in the middle of next year.
Tellez said that at his talks last week with his Venezuelan and Saudi Arabian counterparts, their third round of formal talks this year, the ministers did not discuss any further cuts by Saudi Arabia and other Gulf producers in return for Mexico's agreement to extend its cuts in oil exports from the end of this year through June 1999.
''No, that was not the agreement,'' Tellez said, when asked if there was such a quid pro quo.
Oil prices staged a recovery in recent months after hitting a 12-year low in June but have since begun to slide again. Mexico's average oil price peaked around $12 a barrel in September but stood at $10.68 on Thursday, Tellez said.
The government's budget, based on an average price of $11.50 a barrel, already has been slashed by $4 billion this year.
Saudi Arabia To Study Use Of Oil Futures
In a move that could ultimately have a significant impact on world oil markets, Saudi Arabia's state oil company, Saudi Aramco, is to study the use of futures and other derivatives as a tool to hedge against falling oil prices.
Saudi Arabia, the world's largest oil producer and exporter, has long shunned the use of futures, largely because of worries that its participation in the market would be so influential, akin to the Federal Reserve's position in the money markets.
However, futures have come to play a pivotal role in setting world oil prices since they began in the 1970's and other world oil producers, such as Venezuela and Mexico, have started derivatives trading operations to try to manage their price risk.
Also, the latest collapse of world oil prices over the past year has led Saudi Arabia and others to consider changing the old order, which was dominated by the cartel quota system of the Organization of Petroleum Exporting Countries (OPEC). And within Saudi Arabia, there has been a move toward liberalizing the economy, including recent talks by heir apparent Crown Prince Abdullah with oil company executives about the possibility of participation in some parts of the Saudi energy sector, such as natural gas and power.
The derivatives training course for the Saudi executives is to be run by the New York Mercantile Exchange (NYMEX), the world's largest exchange for oil and other energy futures. It is expected to begin in early November and cover all aspects of futures, options and other derivative securities trading, including accounting and the back office systems needed to support such an operation, according to sources familiar with Aramco's plans.
''It's a big deal,'' said Ed Krapels, director of Energy Security Analysis Inc. in Boston and an energy derivatives expert. ''It's a good sign and in keeping with other moves to liberalize.''
Its impact on Saudi Arabia and on the oil markets depends on whether and how the Saudis follow through on their initial study of the futures market. If they take a very conservative approach and slowly build up a program designed to smooth the impact of volatile oil prices on the country's revenues, which have been cut 50 percent over the past year, then the impact would be benign, Krapels said. But if they were to view the derivatives markets as a method to try to prop up oil prices, then it could be very disruptive.
''The analogy with the Federal Reserve is a good one because the Fed has influence, but it's limited,'' said Krapels. "If the market thought the Saudis had a view on where prices ought to be, it would trade against that view. That would be a fool's game and never succeed.
''If I was their advisor, I'd say start small and gradually build up,'' said Krapels, who adds that the whole process of putting together a sophisticated hedging operation could lead Saudi Arabia to break a long tradition and allow some of its physical crude oil to trade freely.
The decision is likely to be hotly debated within Saudi Arabia.
''Other countries do it -- Mexico and Venezuela -- but for Saudi Arabia, it's different,'' said a consultant currently working for Saudi Arabia, who didn't want to be named. ''The problem for the market is that Saudi Arabia has better information than anyone else.''
He said that Saudi Arabian officials understand that if their trading in the futures market became a liability, it would undermine the market's integrity and kill futures trading. So, they are likely to be extremely careful in their approach to the market as destroying futures trading would not be in their long-term interest.
Oil Producers Should Talk More - Pemex Chief
Oil producers should talk to each other more to be prepared to face future price fluctuations, the chief of Mexico's oil monopoly Petroleos Mexicanos (Pemex) said.
Adrian Lajous spoke at a national convention of chemical engineers and reiterated his call for greater dialogue between oil producers and for timely statistics on oil production and exports, according to a Pemex press statement.
Although his speech was not provided, the statement said Lajous called on oil producers to meet frequently and be prepared to take coordinated action to mitigate market instability and limit radical price fluctuations.
The lack of reliable information on oil production, demand and inventories makes oil producers' decisions and cooperation more difficult, Lajous added.
Mexico, Venezuela and Saudi Arabia spearheaded oil output cuts this year in an effort to boost sagging international prices. Oil producers agreed to cut about 3.1 million barrels per day (bpd) as of July.
Lajous has said countries should provide their oil output and export data to give first-hand accounts of supply levels. Pemex began publishing its data earlier soon after the oil accords were reached. |
