General outlook for the oil market (2)

General outlook for the oil market (2)

The following is the second of a two-part article based on a
paper presented by Subroto at 1994 annual Indonesian Petroleum
Association Convention on Oct. 4 in Jakarta.

JAKARTA: The short term outlook is dominated by at least three
factors, namely a strong demand, a stable OPEC output and
uncertainty about Iraq. The perception is that economic growth is
reviving world-wide. Economic recovery of the Organization for
Economic Cooperation and Development economies, although not as
strong as the recovery in the sixties and seventies, has caused
the market to change its expectations about underlying demand
growth. With a more uniform economic in the United States, Europe
and Asia- Pacific, the underlying oil demand increase will be
substantially higher. By coincidence, demand collapse in the
Former Soviet Union (FSU) seems to have reached the bottom and
stops falling, and consequently world demand will not be dragged
down by it.

According to OPEC's secretariat August monthly report, total
world demand for 1994 has been forecast to reach 65.79 million
barrels per day, an increase of 690,000 barrels per day or 1.1
percent over 1993. This the strongest year to year growth since
1991. As you recall from 1992 to 1993, the demand growth was
negative, minus 0.3 percent.

Since the beginning of 1994, U.S. demand appears to have
increased by four percent. On the other hand, the European
recovery in oil demand is not expected until 1995, when Europe
could take over from the U.S. as the major area of oil demand
growth. Europe will continue to show signs of weakness in the
second half of 1994. Only southern Europe, Italy, Portugal and
Spain, will show some increase in oil demand. Northern Europe
will, despite signs that most economies are heading out of
recession, continue to struggle with high level of unemployment.
Competition from natural gas will severely limit oil demand
growth. In the Asia- Pacific region, consumption continues to
rise at a rate of around 700,000 barrels per day. It has served
in recent years to offset the huge decline of oil demand in the
FSU.

Crude inventories appear rather tight in the U.S. where there
are currently some 21 million barrels below last year's level.
This should underpin the demand for oil imports and OPEC oil for
the rest of 1994. Europe, on the other hand, presents a different
picture with crude inventories some 12 million barrels above last
year, reflecting the situation that their economies have not
quite emerged from the recession. In the Asia-Pacific region
stocks are more or less in balance.

OPEC's production in August, as estimated by secondary
sources, averaged 24.61 million barrels per day, down by 210,200
barrels from the July production. This has been the longest
record of OPEC keeping production very close to the production
quota and contributing to the fact that sofar in 1994 prices have
been relatively firm. The oil market has become far more robust
than the situation at the beginning of the year. The price rises
seen during the second quarter were in large measure a result of
OPEC's policy of holding its output constant over a prolonged
period. If OPEC keeps its output close to its present levels, the
outlook for the end of the year is one of relative low stocks and
upward pressure on prices.

On the Iraqi question, the oil market has been speculating on
the timing of Iraq's return as a major oil exporter for the past
four years. Not only the timing, but also the extent of Iraq's
return will be important, because no doubt it will have a major
impact on prices. Is a partial return of Iraq's oil export a
possibility in the fourth quarter of this year? Although not
impossible, it looks unlikely, but the uncertainty of its return
works as a price-depressant in an otherwise bullish outlook for
the last quarter of this year.

Practically all oil demand forecasts for 1995 are in general
guardedly optimistic. OPEC's secretariat reports that the total
world demand in the first quarter of 1995 at 67.79 million
barrels per day, an increase by 770,000 barrels per day or 1.2
percent, compared to the same period last year. For the second
quarter the estimate is 65.07 million per barrels per day, an
expansion of 890,000 barrels per day or 1.4 percent over the
second quarter last year. OECD demand is expected to be 39.35
million barrels per day, indicating an increase of 350,000
barrels per day or 0.9 percent for the same period last year.

For the non-OECD countries the increases are 360,000 barrels
per day and 490,000 barrels per day, bringing their oil demand to
28.38 million barrels per day and 27.99 million barrels per day,
for the first and second quarters of 1995 respectively. The
expected call on OPEC oil and stock for the first quarter 1995 is
estimated by the OPEC secretariat to be 26.59 million barrels per
day and for the second quarter 24.22 million barrels per day.

Other forecasts are stating that world oil demand is well set
on the road of recovery. The rate of annual demand growth in 1993
was 100,000 barrels per day. In 1994 the forecast is that it will
increase by 900,000 barrels per day and in 1995 the increase is
expected to be 1.1 million barrels per day or an increase of 1.7
percent on a year to year growth rate. The demand for OPEC oil is
in turn expected to be around 26.4 million barrels per day,
representing the highest average daily level since 1980.

How the market will develop and how oil price will behave
during 1995, will very much depend how OPEC's response will be to
the rising call of its oil. OPEC's production policy in 1995 will
still be influenced by the prospect of Iraq's return to the
export market. Will they maintain their output below the expected
call for their oil for some months, in order to accommodate
Iraq's return to the oil market, without a substantial cut back
to their production, which is politically a difficult decision to
take. This makes the forthcoming OPEC's year-end conference on
the Nov. 21 in Bali so interesting, because it will give the
answers to the very question the oil industry is posing.

How will OPEC fare in the future. How will it respond to the
challenges of the second half of this decade and beyond. Will it
still have a role to play as we enter the 21st century. The most
pressing challenge OPEC is facing, is to sustain oil prices at
least at the present level and prevent them from falling.
Preferably OPEC should keep the present production level until
the second quarter of 1995. As stated before, the expected world
demand for the first and second quarter of 1995 are 67.79 million
barrels and 65.07 million barrels respectively.

The call for OPEC oil and stock is estimated to be 26.70
million barrels and 24.34 million barrels for the first and
second quarter respectively, implying a stock drawdown of 1.7
million barrels in the first quarter and a stock build up of 0.66
million barrels, provided OPEC stays below 25 million barrels per
day in the 4th quarter 1994 and continues to maintain that level
in the first and second quarter.

There is no reason why prices should not continue to be
moderately firm during the rest of this year and the first half
of 1995. This should be OPEC's policy now and in the future, to
keep prices firm but moderate while assuring consumers that the
supply of oil is in responsible hands, since practically all
member countries are at production capacity and only a handful
countries with a good track record in quota adherence are having
excess capacity. The wild card is Iraq. Will it enter into the
market or not in 1995, if yes when it will be and by how much.

Regardless of what OPEC's decision will be in November, for a
long time to come, OPEC will remain a heavy weight among
producers by virtue of the seize of its reserves, low cost
production and longterm impact. The key issue remains how OPEC
will act in an environment of weak oil prices in real terms. Will
OPEC decide to invest in increasing production capacity to
provide adequate supply when demand goes up.

Not, if prices remain low in real terms and consuming
countries continues to tax oil and oil products unfairly. Today's
market with low real oil prices, is hardly an incentive to
investment to increase production capacity. Yet in fact the gap
between supply and demand is very tight, may be not more than
three million barrels. According to our figures, world oil demand
is expected to increase to nearly 73 million barrels per day in
the year 2000 from the present demand of 67 million barrels per
day, under an US$18 price scenario.

Dr. Subroto is a former secretary general of OPEC.

Window A: If OPEC keeps its output close to its present levels, the
outlook for the end of the year is one of relative low stocks and
upward pressure on prices.

Window B: World oil demand is expected to increase to nearly 73 million
barrels per day in the year 2000 from the present demand of 67
million barrels per day.