Oil prices are beginning to soften a bit as the market's physical fundamentals improve.
But any oil price decline is likely to be fairly modest. That's because the underlying price engine of surging demand likely will remain in place, and the overlying threat of oil supply outages due to terrorism or civil strife still will linger.
The Organization of Petroleum Exporting Countries will meet in July to discuss whether to carry out the second, 500,000 b/d part of a two-stage production quota increase eventually totaling 2.5 million b/d. No doubt the group's first concern regarding the decision to take that extra step will be a look at the state of crude oil and product stocks. And what it sees may validate the Saudi-led push to moderate high oil prices but at the same time signify a potential threat on the downside of price stability.
According to Energy Security Analysis Inc., Wakefield, Mass., robust refining margins have kept crude demand high, and the resulting high throughput rates have helped rebuild gasoline stocks. It is that improving gasoline stocks picture that accounts for the sizable price decline in gasoline prices the week of June 21. ESAI sees a brief dip into deficit in the global oil supply-demand balance for July-August before rebounding into surplus in September-October. By this time, stocks will have recovered to the point where prices will hover near $30/bbl (West Texas Intermediate) for the rest of the year, under ESAI's forecast.
OPEC's role
But has the game changed for OPEC? Has there been such a powerful renaissance in oil demand that the group needs to shift its focus away from defending price to defending demand growth?
Until recently, OPEC had done a masterful job in managing supply at the margin so as to support a price level closer to $25-30/bbl (WTI), roughly equal to its now-defunct target price band of $22-28/bbl for a basket of crudes.
But OPEC was as surprised by this year's demand surge as the rest of us—which says a great deal about oil prices breaching $40/bbl in recent months. And London-based think tank Centre for Global Energy Studies contends that OPEC "still appears to be underestimating the strength of the market in 2004, estimating incremental demand at less than 2 million b/dU. The world economy is expected to grow by 4.6% in 2004, and the CGES believes that global oil demand will increase 2.25 million b/d (2.8%), despite a 17.5% expected rise in crude oil prices."
Blunting the impact of high prices on demand have been the weakness of the US dollar and subsidies and high fuel taxes in some countries. So the market has not yet reached a tipping point where there could be enough of a dent in demand to cause a price collapse.
And refiners' throughput will need to stay high through the third quarter in order to accommodate the usual seasonal surge in demand in the fourth quarter. So OPEC collectively may have to think twice before retracting the promised 500,000 b/d cut, which would take effect Aug. 1, out of concern for market stability.
"In order to meet surging demand over the coming winter, OPEC will need to allow commercial stocks of oil in consuming countries to be rebuilt over the summer—something it has been reluctant to do in recent years," CGES said in its June 21 monthly oil report. "In the current climate, where fears of a supply disruption continue to support oil prices, OPEC should have little to fear from rising consumer stocks of oil."
Terror campaign
Certainly some of the premium in today's oil price owes to those fears of a supply disruption. They aren't going away anytime soon, and there remains a strong likelihood those fears could be borne out any day.
In the meantime, OPEC's spare production capacity has been whittled to a sliver; as long as that situation holds and the threat of outages hold, fears of a price collapse should take a back seat to feverishly adding more production capacity.
That's what makes the current terrorist attacks in Saudi Arabia so worrisome to oil market watchers.
Says CGES: "The attacks against Westerners in Saudi Arabia are unlikely to have an impact on the kingdom's current oil production, but they could divert both political attention and funds away from much-needed upstream oil projects."
The 500,000 b/d production quota hike should be a no-brainer.
(Online June 28, 2004; author's e-mail: [email protected])