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.