The oil producing countries of the Middle East should be well satisfied by the market trends of the first three months of 1995. Conditions are stable, oil demand is edging up, prices have improved since the start of the year and more of the same is in prospect for the rest of the year. OPEC abandoned its effort to dominate the market nearly 10 years ago, having seen its share shrink in the process. Today, OPEC is delivering a steady volume into a growing market and prices have picked up in response.
So, why is there no rejoicing to be heard? The reasons for disenchantment are plentiful. Prices lie at the root of it. The new year price recovery peaked in mid-February when the OPEC basket reached $17.40 a barrel; the basket had retreated to less than $17 a barrel by the end of March. This is a far cry from $21 a barrel which remains the OPEC target. And, the dollar earnings are not worth as much either. The US currency, in which oil sales are denominated, has been the big loser in the recent turbulence in the markets and the purchasing power of Middle East oil producers has been reduced (see page 24).
In fact, little is going OPEC’s way. The decision to fix output at 24.52 million barrels a day (b/d) for the whole of 1995 was intended to signal that there was no longer anything to be gained from speculating about OPEC’s intentions. In that it may have succeeded. But, the quotas have not been honoured. The quota refers to supply rather than production, but OPEC wellhead production has been above 25 million b/d since the start of the year. Average production in February was 25.11 million b/d, or 590,000 b/d above quota, according to the OPEC secretariat.
OPEC must thank bullish demand for the fact that oil prices have increased rather than imploded over the past three months. ’25 million barrels a day looks like a floor rather than a ceiling,’ says Mehdi Varzi, energy analyst with Kleinwort Benson in London.
Given the scale of OPEC overproduction there seems little chance that members could be persuaded to reduce output in an attempt to lift prices a little higher. Although OPEC is supposed to review its current quota agreement in June if prices are still below $21 a barrel, there is no expectation that it will. ‘There is an increasingly fatalistic attitude. The vast majority are acting like non-OPEC members. They are pumping to capacity and will carry on doing so,’ says Nick Antill, energy analyst at Barclays de Zoete Wedd (BZW) in London.
The three OPEC producers with some spare capacity – Kuwait, Saudi Arabia and the UAE – have no interest in sacrificing output to accommodate the more hawkish OPEC elements, such as Iran, that might press for cutbacks. Says Antill: ‘They have no ability to threaten. In reality they can’t do anything to change the situation.’
Most analysts discount any prospect of a reduction in the current quotas before Iraq is reintegrated into the OPEC structure. Saudi Arabia, which accounts for about a third of OPEC production, would also have to show some leadership on the issue. ‘OPEC is in limbo because of Iraq and nobody wants to meddle with quotas,’ says Varzi.
OPEC’s other cause for concern is the growth of non-OPEC supplies. According to the Paris-based International Energy Agency (IEA) global demand is expected to average 69.2 million b/d in 1995, an increase of 1 million b/d over last year. The rise is powered by the economic recovery in the industrialised countries and strong demand growth in the Far East.
This should be good news for OPEC, but it isn’t. All of the growth in demand is expected to be satisfied by non-OPEC sources. North Sea output is heading for historic highs in 1995 and Russian output is likely to bounce back by about 200,000 b/d. Smaller additions to non-OPEC supplies are coming from Africa, South America and the Far East. In total, non- OPEC supplies will rise by 800,000 b/d in 1995, according to IEA projections. This leaves a gap of 200,000 b/d, but OPEC won’t even get the chance to cover this small amount.
‘You must factor in the drawdown from inventory,’ says Kleinwort Benson’s Varzi. He expects a stock draw of about 200,000 b/d this year which will account for the rest of the growth in demand. ‘OPEC has no choice but to sit tight, be patient and wait for demand to grow.’
Seasonal factors will also be testing OPEC’s patience this spring. With refining margins still under pressure, many oil refineries are slowing down to conduct maintenance work. Refinery maintenance programmes in Europe, Saudi Arabia and India in March and April will be followed by similar cutbacks in Japan and Korea in May and June. The lower refinery throughput volumes will reduce demand for crude oil just as North Sea output is expected to rise. While this points to some short term uncertainty, analysts detect a longer term problem for refiners – excess capacity.
The Atlantic basin now has too much upgrading capacity because of the heavy investment in new cracking capacity in the late 1980s, according to BZW’s Antill. Refining margins are weak and, to compound the problems caused by overcapacity, supplies of Middle East light crude are higher than expected. In response to these difficulties, oil prices were in backwardation for the first two and half months of the year, with forward Brent languishing at a discount of 50 cents a barrel to the prompt delivery price.
This suggests that the recent price improvements are still not secure. Oil prices were delicately poised at the end of March, having shed some of the gains they made in January and February. However, analysts are sticking with the cautious projections they made at the start of the year (Saudi Arabia, MEED Special Report, 20:1:95). For example, Kleinwort Benson fully expects its forecast of an average $17 a barrel for Brent in 1995 to be borne out.
The outlook for OPEC is less encouraging. Despite the desperate need for most OPEC states to boost earnings and reduce budget deficits, the group has no leverage over prices at this time. And when Iraq is allowed to export oil again – still a very distant prospect – OPEC’s quota quarrels are likely to revive in earnest. For this year, at least, OPEC is condemned to a spectator’s role in the oil market. It can watch while demand rises, but has little prospect of sharing in the proceeds.