Oil price scenarios:
Global Intelligence Update
Red Alert
August 5, 1998
Kuwait and Saudi Arabia Mull Third Round of Crude Oil Production Cuts
Saudi Arabia has reportedly joined Kuwait in contemplating the possibility
of a third round of crude oil production cuts, in an attempt to bolster
prices. An anonymous source "familiar with official Saudi thinking" told
Reuters on August 3 that Saudi Arabia may back another round of production
cuts if world oil prices remain stagnant into September. The source was
quoted as saying "If in September OPEC made good on its commitments [to cut
output] and prices did not improve to much higher than where they are now,
then Saudi Arabia and OPEC may not have to wait until [the scheduled OPEC
meeting in] November" to agree on further cuts. The source reportedly
refused to state Riyadh's target crude oil price.
On July 29, Kuwaiti Oil Minister Sheikh Saud al-Nasir said at a press
conference at Kuwait's National Assembly that OPEC members should consider
additional production cuts if the price of Brent crude does not reach $17
by November. Sheikh Saud told Kuwait's "Kuna" news agency, "My policy is
totally clear. It favors output reduction. We are monitoring the market.
If prices do not improve, we shall reconsider the output quotas which were
agreed recently." He suggested that a further cut of one million barrels
per day may be necessary to reach price targets.
The collapse of oil prices in 1998, driven in large part by sharply reduced
Asian demand, has had a severe impact on the economies of oil producing
countries. In an attempt to remedy this situation, Saudi Arabia was
integral in forging two rounds of production cuts between OPEC and other
major non-OPEC oil exporting countries. The first agreement was brokered
in Riyadh in March and the second occurred in Amsterdam in June. Together
these agreements resulted in a total promised cut in production of 3.1
million barrels per day from February 1998 levels. However, this has had
little effect on world oil prices. Brent crude spot prices and futures
remain under $13 per barrel, $6 below the same period in 1997 and near
their lowest level for 1998, and they show no sign of rising in the near
future.
While there has been some cheating by signatories to the two production cut
agreements, the fundamental problem with these agreements, and with any
third round of cuts, is that they are simply not enough to eliminate the
global oversupply. Thus far in 1998, world consumption of crude oil has
averaged 74.6 million barrels per day, whereas world production has
averaged 75.7 million barrels per day. The Kuwaiti-proposed additional
million barrel per day cut would almost, but not quite, eliminate this
surplus. That is assuming 100 percent compliance, and experience from the
previous two agreements suggests more along the lines of 80 percent
compliance.
On top of this, non-participants in the production cut agreements have
increased production in 1998 in an attempt to maintain revenues, and Iraq
is preparing for a major increase in production. Even if an agreement
could be forged to balance supply and demand, it would be some time before
crude prices rose significantly, as world crude oil inventories remain
glutted, Asian demand is expected to remain suppressed the next few years,
and new production continues to come online.
Commercial oil inventories, which are measured in days of supply, have
increased in Organization for Economic Co-operation and Development (OECD)
countries to 27.7 days of supply in 1998 from 26 days of supply in 1997.
Even with production cuts in place, global inventories are continuing to
grow by 1.1 million barrels per day as refinery utilization has remained
near capacity. Upward pressure on prices caused by any additional
production cuts will be buffered by inventory draw-down. Furthermore,
production cuts do not change the fact that Asian demand has plummeted with
the region's financial meltdown, and as China gets swallowed up in the
crisis, demand will only sink further.
Production cuts also fail to change the fact that new technology has made
oil easier and cheaper to locate and produce. Development in some areas,
such as Central Asia, has slowed due to cutbacks in national and corporate
exploration and production budgets. But if prices begin to rise, these
projects may resume development, threatening once again to drive prices
back down. The imbalance between supply and demand, with the resulting low
crude prices, looks ready to become a long-term phenomenon.
Barring an unexpected and highly unlikely recovery in Asian demand, only a
dramatic, involuntary, and prolonged reduction in production has any hope
of raising crude prices. One solution, reportedly suggested by Iran at the
June 24, OPEC meeting in Vienna, would be for OPEC members to halt
production altogether, allow inventories to decline, then resume carefully
quota-governed production. This is almost unthinkable, as cheating would
be inevitable and the loss in market share to non-OPEC producers would be
unacceptable.
A second alternative would be to take a single major producer offline. We
have argued that such a plan is already underway for Iraq. The doubling of
Iraq's quota in December 1997, coupled with already surging illegal
shipments, has been a major depressing factor in the world oil market.
Indeed, many Gulf States have shown growing animosity towards Iraq's
position. Kuwait and Iran have been increasingly at odds with Baghdad in
the past several weeks, and appear to be making a political case for the
forcible removal of Saddam Hussein. The U.S. is also once again publicly
committed to the ouster of Hussein. With talks between UNSCOM and Iraq
broken down, potential for an attack on Iraq has increased.
In one final note, an unconfirmed report in the Paris-based weekly
"Editor's News" on August 1 claimed that U.S. House Speaker Newt Gingrich
and Senate majority leader Trent Lott have privately urged the Clinton
administration to launch air strikes against the recently repaired Iraq-
Syria pipeline. This report is odd, as it is questionable whether the
Republican leaders would offer President Clinton a high-profile foreign
policy distraction just as the criminal investigations of the Democratic
President appear to be bearing fruit. But if there is bipartisan support
in Washington for an attack on Iraq, Clinton would be loath to turn down
such a choice political escape.
Two rounds of production cuts have failed to affect crude prices. The
Asian economic crisis is worsening, with little hope for a rebound in crude
oil demand. Oil producing nations are once again looking for a solution to
their economic problems. And the leader of the one world superpower,
having declared a desire for friendship with Iran and for the overthrow of
the leader of Iraq, is desperate to distract the media and public attention
from Monica Lewinsky's dress. We have made our call. What are the
alternatives?
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