The oil market seems to have turned a corner. Prices are skidding. Talk of $10/bbl oil next year has replaced last August's declarations that the world had seen its last $20/bbl oil.
There are good reasons for the change. Half a Northern Hemisphere heating season has passed without serious disruption despite loss of oil from Iraq and Kuwait. Unless the Middle East crisis becomes war, the market can probably handle the heating season's second half, whatever the weather. Suddenly, war appears unlikely. The petroleum industry now must prepare for a price slump and a new round of criticism.
EFFICIENT RESPONSE
A price slump looms because of the market's efficient response to the supply disruption following Iraq's invasion of Kuwait Aug. 2. Since then, the International Energy Agency has reduced its estimate for fourth quarter demand outside centrally planned economies by 1.2 million b/d. And production has increased by 4.1 million b/d, all but 200,000 b/d of it from members of the Organization of Petroleum Exporting Countries. Saudi Arabia alone has increased output by 2.6 million b/d to a level that exceeds earlier estimates of its production capacity by 1 million b/d.
A combination of higher production and lower demand, therefore, has compensated for loss of 4.3 million b/d of oil from Kuwait and Iraq. A lack of spare capacity makes it a shaky balance. But high inventories provide a buffer against unusually cold weather the rest of the heating season. With the war threat easing, production outside Kuwait and Iraq, especially Saudi Arabia's pivotal output, seems safe.
The question now is what happens when Kuwait and Iraq resume oil production. OPEC last week said it would reimpose production quotas when the crisis ends. But OPEC ceilings have an historic problem: They leak. And they may prove especially troublesome this time. Which OPEC members will surrender market share to Iraq so Saddam Hussein can resume construction of a Middle East war machine?
An oil price slump is a small price to pay for escape from warfare in the Middle East. But it will test industry's planning ability and investment resolve. And it provides a way to respond to the new criticism likely to develop. Detractors will look back, fail to see a physical shortage, and demand to know why oil product prices shot up after Aug. 2. Industry should provide the answer now, with the market apparently ready to demonstrate the back side of a classic cycle.
A MISTAKEN NOTION
Suspicions arise from the mistaken notion that prices can't or shouldn't rise unless there's physical shortage. Again and again, industry must point out that prices reflect collective buyer and seller judgments about future supply and demand. When shortage threatens, buyers concerned about future supply and sellers concerned about replacement volumes bid up prices. Consumption then declines, production increases, and physical shortage doesn't materialize-unless, of course, something, such as price controls, interfere with the adjustments.
Now that supply anxieties are easing, industry should turn the old myths around on its critics. Should a physical surplus develop, should tanks overflow and pipelines burst, before prices are allowed to drop?
Industry also should remember that price extremes never last. An OPEC market share baffle may indeed develop. Prices may again approach $10/bbl. But the August forecasts were wrong in both directions. The world hasn't seen its last $20/bbl oil. Maybe it never will.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.