The Organization of Petroleum Exporting Countries doesn't look so mistaken after all. For its late-March decision not to cut production quotas, the exporters' group received scoldings from many sources. "Failure" to trim production, the critics warned, would push crude prices to the basement. Yet in the intervening month and a half, crude prices have risen by roughly $3[bbl.
The point here is not to congratulate OPEC and ridicule the doomsayers. Indeed, OPEC had little choice in March but to extend its quotas. OPEC's test comes now, with rising oil prices tempting members to overproduce and annul the gains. And price doomsayers deserve sympathy. Most of the time, nearly everyone is wrong about future oil prices. Next time, crude prices might just crash, vindicating the fretful.
RECOVERY IN PROGRESS
Even in March, however, a market recovery was in progress. As often happens, it showed up first not in quotes for Brent forward contracts or light, sweet crude futures on the New York Mercantile Exchange, but in product value gains in the U.S. and Europe. Rising product prices meant oil demand was rising, a welcome trend borne out in later reports from the International Energy Agency. According to IEA's latest Monthly Oil Market Report, demand among members of the Organization for Economic Cooperation and Development during the first quarter averaged 40.6 million b/d-the highest level for a single quarter in nearly 15 years. IEA now expects world demand to rise 800,000 b/d this year to 68 million b/d.
Unpredictable though the oil market may be, one thing is certain: When demand rises and supply does not, prices increase. That's why crude values have jumped. But how long will the upswing last? Refining margins must widen to support recent crude gains, which means product values need to rise further in a market that might balk. And sooner or later supply will increase from OPEC cheating-although most usable spare capacity belongs to members least inclined to overproduce-or from non-OPEC responses to higher prices, or from both. Nevertheless, with economies growing in the U.S. and Asia and recovering in Europe, the basis for durable demand strength is in place.
For the industry, developments that have brought the market to this point offer lessons. One is that momentary price swings don't matter much and that most nonmarket events that swing prices momentarily don't matter much either. In fact, there is only one such external factor of major significance at work now, and it is the international trade embargo on Iraq. Besides that, nothing is as important to oil prices over time as are global economic recovery and demand growth.
OTHER LESSONS
Another lesson is the folly of assuming that the future amounts to an extension of present trends. No commodity market works that way, and oil-it should be obvious by now-is a commodity. When, a few years ago, crude traded at $17-22/bbl, there was no valid reason to assume that it would do so indefinitely. When, a few months ago, crude prices dropped to less than $15/bbl, there was no valid reason to assume that they would sink all the way to $10/bbl. When prices settle into a trend, supply and demand adjust in ways certain to alter the course.
A final lesson, then, is the futility of still-common hopes for "price stability." Yes, stability would be nice. It's just not likely to come about in a market in which supply, demand, and price move freely in relation to one another. Future prosperity belongs to business people who recognize this reality and learn to generate profits in spite-or perhaps because-of it.
Copyright 1994 Oil & Gas Journal. All Rights Reserved.
