Changing equilibrium in international oil market

Kurtubi, Energy Analyst, Jakarta

On March 17, 2004, the price of oil on the world market reached a record high for the past two decades. The price of light crude of WTI (West Texas Intermediate) type, which is the benchmark for oil prices in the American region, went beyond the level of US$38.18 per barrel. The previous high for WTI came about during the second oil crisis in 1980, a situation triggered by the Iranian Revolution, when it reached $37.96 per barrel.

Are the recent changes in the prices of oil a signal that actually the world oil market equilibrium is undergoing a change? Or, are the "high" oil prices in the first quarter of 2004 simply a temporary phenomenon brought about by the several months of cold weather in the northern hemisphere.

In terms of a short-term perspective, namely in the context of seasonal movements, the soaring oil prices in the first quarter of 2004 are only a temporary phenomenon that will disappear as the weather warms up. Nearly every year, every time the first quarter begins, oil prices will strengthen because the need for oil increases during cold months -- mainly for household/office heating. Then these prices will weaken in the second quarter as demand decreases.

That's why the OPEC meeting of Feb. 10, 2004 in Algiers decided to cut the quota from 24.5 million barrels per day (mbpd) to 23.5 mbpd as of April 2004. In the second quarter of 2004, it is estimated that the demand for oil on the international market would drop by about 3.0 mbpd, namely from about 81.5 mbpd in the first quarter to some 78.5 mbpd in the second quarter.

In the OPEC meeting to be held on Wednesday, it is very likely that the cut will be realized although many parties have expressed their worries about the fact that oil prices have remained "high". On the other hand, if OPEC fails to cut the supply in the second quarter of 2004, it is almost certain that there will be an oversupply. Consequently, there will be a sharp drop in price, a situation that is, of course, not to OPEC's liking.

However, viewed in a longer-term perspective, there are sufficiently strong factors to support the inclination of the oil prices to remain "high", a condition that began to develop in 2003 and is likely to last for a fairly long time. So, the "high" price of oil at about $30/barrel is not just a transient condition as this may be a signal that the world oil market equilibrium has actually now moved upward.

This means that the market fundamentals, namely supply and demand on the world market, have now undergone a change in which the rise in demand has exceeded the increase in supply. That's why, the "high" price phenomenon seen in the past year is not just a transient condition.

In fact, this upward price movement began about a year ago. Following the toppling of the Iraq regime, the price of oil in the international market remained "high", at around $30/barrel, quite unlike the estimate that many parties had made that this price would again return to its "normal" level of about $22/barrel, which is the floor benchmark of OPEC price range.

Statistics show that all through 2003, oil prices remained at around $31.5/barrel for the WTI type and about $28.5/barrel for the OPEC basket, a level exceeding the ceiling benchmark of OPEC price range ($22 -- $28/barrel). This condition was attributed to a relatively high demand for oil, namely about 1.5 mbpd over the demand recorded in 2002. This 2003 rise in demand far exceeded the average increase in demand over a period of four years (1999- 2002), which was recorded at about 0.8 mbpd, especially when it was compared with the 2002 rise in demand 2002 of only about 0.2 mbpd, which was very low as a result of the Sept. 11, 2001 tragedy.

Meanwhile, in terms of the supply side, OPEC is now able to control the quota (although the degree of compliance to this quota has never reached 100 percent) so despite additional supplies from non-OPEC countries, which are not subjected to the quota mechanism, the shift in the world oil supply curve is still lower than that of the demand curve, therefore causing the prices formed in 2003 not only to far exceed the average prices recorded in the past five years but also to reach the highest level since 1983.

Unless there is something extraordinary like another Sept. 11, which slows down economic growth and weakens the world demand for oil, the future the demand for oil in the world market is expected to continue to rise far above the average prices registered over the last five years.

The United States, which is the world's largest consumer country with its consumption of around 26 percent of the total oil consumption in the world, is expected in 2004 to consume around 20.4 mbpd, a rise of around 0.3 mbpd compared with 2003.

In the next five years, this quantity will continue to rise to around 22.0 mbpd in 2009, a condition that will make the United States increasingly dependent on imported oil. The reason is that U.S. domestic oil production will not increase until 2013, namely after its project in ANWR (Arctic National Wildlife Refuge) in North Alaska starts production. Even when production in this area kicks off, the output will only be around 1.5 mbpd.

Likewise, China and India will see their demand for oil continue to rise because their populations are huge and their economic growth rates are above the world's average while their domestic oil production is highly limited.

In view of a very rapid increase in the number of motorized vehicles and in the expansion of its toll roads, the demand for oil in China should be massive. While in 2004 China requires about 5.6 mbpd, it is estimated that in 2009 this country will need around 7.0 mbpd and half of this quantity will have to be imported.

Despite a relatively high growth in demand in 2003, a condition that has jacked up the prices of oil to their present "high" level, in the real value, which is obtained when the normal price of oil every year is divided by the rate of inflation, the real prices of oil in 2004, actually, are much lower than those registered in 1983. Likewise, the total value of the income of oil-producing countries in the past two years have gone down by around 30 percent as a result of the plummeting of the U.S. dollar against the Euro.

Still, the prices of oil in the future remain uncertain. Aside from the factors that will continue to make the oil prices remain strong, there are also factors that weaken them.

Given the inclination of the growth in demand to strengthen in line with the world's economic recovery, particularly in the United States, China and India, and in view of the increasingly declining value of the OPEC countries' earnings from oil, the "high" prices of oil have a great chance of remaining at their present level, particularly if OPEC revises its target for the prices to reach a level that is more realistic at around $25-$32 per barrel with the mid-rate of $28.5 per barrel.

For Indonesia, the impact of these "high" oil prices will be more advantageous because statistics show that at present the country's foreign exchange earnings from the oil and gas sector still register a surplus, namely that the value of exports exceeds that of imports.

Another advantage is that high oil prices can also stimulate more oil and gas investment and production. In the meantime, the additional financial burden that has to be shouldered following the fulfillment of the domestic demand for fuel oil, necessitates the integration of the policy on the prices of fuel oil with the policy on national energy with account being taken of the domestic fuel oil market structure.

The next step will be the drawing up of a more realistic state budget so that planned receipts from the oil and gas sector can push the plan to create more employment opportunities and control over how the state budget is spent must be exercised more effectively.

Given a more realistic reference price of crude, Pertamina, now a state limited liability company (PT Persero) and still a supplier of domestic fuel oil, will be able to ensure that its investment planning and calculation of the price of fuel oil will be closer to the reality on the ground.

An overly conservative and very low benchmark price may result in risk aversion on the part of Pertamina and the company would lose the opportunity for business development and expansion, such as acquisition, the construction of new oil refineries, etc. All because it will be hampered by inaccurate economic calculations due to the impact of a non-business-oriented oil price assumption.

On the macro side, it will be more appropriate for the future state budget to use more realistic crude price assumptions than those that have for many years remained conservative at $22/barrel while in the past three years the prices of oil in the market have reached around $28-$30 per barrel.

A more realistic price will mean a bigger planned revenue in the state budget, which, in turn, will mean a bigger budget allocation for development projects. Eventually, there will be more employment opportunities and more public control over budget spending.