Opec's oil price party ends as the world economy trembles

07 September 2007
Mohammad Alipour-Jeddi, head of Opec's market analysis department, was ruminating at the annual meeting of the Japan Co-operation Centre for the Middle East in Vienna on why economists have been so wrong about oil price trends since 2003.
The pattern of dodgy forecasts continues. Alipour-Jeddi questioned the recent International Energy Agency (IEA) projection that world demand will increase by 2.2 million barrels a day (b/d) in 2008.

This is a bad time for the gloomy profession. Economists failed to predict the doubling in oil prices in the past four years and were startled when world growth did not drop in the aftermath. Perhaps determined to dispel their reputation for being too bearish, most in 2007 adopted the opposite tack. The consensus forecast in the first half of the year was that the world boom would continue into 2008 at least.

It was too good to be true. And, inevitably, the world has delivered a dose of reality. In August, US financial markets suffered their most serious setback since the equity crash of 1999, the cause and consequence of the last world recession. Governments have pumped in liquidity and insist it is a minor setback. But experience suggests this cannot be the case. Inescapably, US growth will slow, holding back everywhere else. The annual IMF/World Bank meetings in October are likely to hear bad news about 2008.

Opec is already anticipating downward oil price pressure. But why has it taken so long to happen? Opec's answer is five factors that combined in the first half of this year to keep prices close to 2006 levels. Unexpectedly strong world growth pushed up oil consumption, particularly in Asia which accounted for more than half of last year's demand increase. Non-Opec supplies have grown less rapidly than expected. There was no non-Opec oil production increase in 2005. Last year, it averaged a modest 400,000 b/d.

Market attitudes have been influenced by Opec spare capacity trends. It has fallen by more than two-thirds since 2002 as leading oil exporters increased output to restrain prices.

Downstream bottlenecks, particularly in the US, have played a role. By mid-2007, global spare refining capacity was 10 per cent, compared with more than 12 per cent at the end of the 1990s. The final factor has been increasing activity in oil futures markets, where political risk concerns have held prices up.

Opec has been convinced for more than a year that oil prices are more likely to fall than to rise. After increasing combined production between July 2005 and July 2006, the organisation has since taken production down. The Opec-10 ceiling was reduced in two steps in Doha and Abuja last autumn. Total Opec-10 output is about 1.5 million b/d lower than it was a year ago.

Opec's actions led to claims that it was manipulating the market to keep prices high. The organisation argues that key indicators, including world oil stocks, show that the underlying trend is for prices to drop. Its members, no doubt, have meanwhile enjoyed the unexpected oil income windfall that 2007 delivered.

Opec says 2008 world oil demand growth will be flat at 1.3 million b/d, a figure that could be too high if the world economy goes bad. Non-Opec output is finally accelerating and could hit 900,000-1.1 million b/d in 2008, more than twice the 2006 figure. Opec spare production capacity is increasing.

The joker is geo-politics, but tensions about Iran's confrontation with the US are subsiding. President Bush's political decline is deemed to reduce the chances of unilateral action. Even the weather has been kinder. Hurricane Dean was no Katrina.

The long-anticipated oil price reverse is approaching. How big it will be is the main unsettled question. History is no guide. Since 1970, the annual average oil price has been about $22 a barrel. The variation around the mean has been almost $15 a barrel on the downside and more than $45 a barrel on the ups

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