Oil off the boil

31 May 1996

The prospect of Iraqi oil returning to world markets in the next few weeks is merely the latest in a growing list of factors that have made for volatile oil prices this year. Most of the pressures since late 1995 have been on the upside and prices have soared beyond expectations.

The return of Iraq is putting pressure on the downside just as the market passes its usual spring peak and starts the slide into the third quarter, the season of soft prices. There is little expectation of a price collapse, but the record prices achieved in the first quarter may not be revisited for some time. And OPEC finds itself back in the spotlight, with the world waiting to see if it can respond coherently to the return of its errant member.

The oil producing countries have profited handsomely from the tight market conditions that prevailed throughout the winter. Oil stocks in the OECD countries were exceptionally low at the start of the year, at only 59 days of forward cover, compared with 63 days at the start of 1995.

When this was allied to a sustained bout of cold weather and an average shortfall in supplies to the OECD countries of 600,000 barrels a day (b/d) in the first quarter, the stage was set for a classic price spiral. This July occurred as the market rose to a fiveyear peak on 11 April: Brent closed at $23.76 a barrel, Dubai was $19.33 and WTI reached $25.43. Brent prices have since fallen by 25 per cent: WTI is down by nearly 20 per cent; and Dubai is 15 per cent lower.

During this period the OPEC states have enjoyed significantly higher earnings. The Centre for Global Energy Studies (CGES) in London calculates that Saudi Arabia's first quarter oil revenues were 11 per cent higher, at $12,000 million, compared with $10,800 million in the same period of 1995.

For OPEC's leading quota-buster. the income boost was even more substantial: Venezuela's export revenues rose by an estimated 25 per cent to nearly $3,800 million from $3,000 million in the first quarter of last year. CGES expects OPEC oil revenues to be $8,000 million higher than last year during the first half of 1996, and $6,200 million higher in the second half.

Analysts were taken aback by the strength of oil prices in the first four months of the year and point to the exceptionally low stock levels as explanation for the surge in demand for prompt oil. At one point spot prices were at a premium of $5 a barrel to futures.

'The backwardation of $5 a barrel was almost unprecedented,' says Leo Drollas, chief economist at the CGES. 'People were desperate for prompt oil'. And stocks are still much lower than usual which is helping to support prices and moderate the downward pressure that is usual at this time of year. 'So much stock has been taken Out because of the cold winter that stocks are now so low that prices have ratcheted up,' says Drollas.

The perilous task of plotting where prices will go from here will depend on a variety of influences. The build-up of non-OPEC capacity will get into full swing in the second half, adding more than 2 million b/d to supplies over the full year and outstripping the growth in world demand. Immediate reaction to the Iraq-UN oil-for-food deal was muted and prices rebounded quickly after an initial fall.

Indeed, the impact of Iraq's 600,000700,000 b/d may already be fully discounted by the markets and the actual return could be a non-event. 'So what - we have been waiting six years,' says Irene Himona, oil and gas analyst at Societe Generale Strauss Turnbull. 'The market will register the return of Iraq, but we don't see a price crash in the short term. Long term, it depends on OPEC.'

OPEC has profited from Iraq's absence and the exceptionally buoyant demand for oil during the past five months. Country quotas have been much higher since 1990 to compensate for the removal of Iraq's 3.14 million b/d from the calculations and total OPEC output has been running about 1 million b/d over quota for at least a year. Growing tensions between Saudi Arabia, the defender of quotas, and states such as Venezuela, which pays no need to them, have been masked.

'OPEC is complacent,' says Drollas. And the mix of favourable factors that has enabled OPEC to coast along for the past two years may not last much longer. 'If global stocks were rebuilt then the demand for OPEC oil would not be significantly higher than it was last year.' says Himona.

OPEC oil ministers are due to meet on 5 June and the markets will be watching for moves to accommodate Iraq. 'If oil prices are coming down, then OPEC will meet in panic session,' says Drollas. If adjustments are not made to accommodate Iraqi oil, the CGES expects the OPEC basket price to be about $6 a barrel below current levels by the fourth quarter (see table). Says Himona. 'If the OPEC meeting does not propose anything to accommodate Iraq it will be negative for sentiment.' Conditions were exceptionally positive for oil prices during the first five months of 1996 and it may be up to OPEC once again to ensure a soft landing in the second half.

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