Crude prices off, amid rising risk aversion... Prospects for Kuwait’s budget remain buoyant…
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In its latest economic brief on the oil market and budget developments, NBK noted that, crude oil prices fell sharply in the second half of January, moving closer towards the $70 per barrel (pb) level. After reaching the $80 pb mark on January 11th, the price of Kuwait Export Crude (KEC) fell by $9 to $71 pb by the 26th. Two factors seem to have been catalysts for the fall. First, rising risk aversion across global markets saw a flight to the US dollar, which traditionally puts a damper on crude prices. Secondly, the announcement of new measures to stem the growth of credit in China raised concerns of slower oil demand; China has accounted for 40% of the growth in global oil demand in recent years. Yet despite the latest leg down, more bullish analysts still expect crude prices to remain range bound between $70-80 pb over coming weeks, before pushing higher as tighter crude market fundamentals (including rising demand and shrinking inventories) start to reassert themselves.
The prices of global benchmark crudes enjoyed a slightly longer stay at above $80 pb during January, before dropping back to the low-$70s. The price of Brent crude suffered a peak-to-trough fall of nearly $10, standing at $71.3 on January 27th, while the price of West Texas Intermediate (WTI) managed to sustain a small premium over other blends, falling to $73.6 on January 27th. The January averages for both crudes, however, look set to stand at least 75% above their averages for the same period in 2009 and futures markets are pricing in further modest rises over the months ahead. It is worth noting, however, that the spread between spot and futures prices is now much more compressed (at around $5-10 pb) than during much of 2009, when spot prices were trading at a heavy discount to contracts dated 12-18 months ahead. This seems to reflect the view that current price levels – despite some volatility – are essentially well supported, backed by a recovering world economy and commitment from OPEC to keep prices in the $70-80 pb range.
NBK noticed that, indeed, analysts’ forecasts for global oil demand this year are looking more and more upbeat. The Centre for Global Energy Studies (CGES) has revised up its forecast for incremental oil demand in 2010 for the second month in a row, this time to 1.2 million barrels per day (mbpd), at a 1.4% growth rate, from 1.0 mbpd a month earlier. This compares to its forecast of 0.7 mbpd in November. The centre expects year-on-year growth in demand in every quarter this year, although decelerating as the year unfolds as the base effect from weak growth in 2009 recedes. The International Energy Agency (IEA) has retained its bullish forecast for growth in oil demand of around 1.4 mbpd (1.7%). Both institutions (and others) expect practically all of this year’s growth to come from countries outside the OECD. The so-called BRIC countries – Brazil, Russia, India, and China – for example, could account for half of all the increase in global oil demand this year.
Crude output of the OPEC-11 (i.e. excluding Iraq) registered its ninth consecutive monthly increase in December, rising by 69,000 bpd to stand at 26.682 mbpd. This leaves its output some 1.8 mbpd, or 7%, above its official quota levels, and comes despite the fact that OPEC appeared to reiterate its commitment to its year-old targets last month. The main ‘overproducers’ were Iran, Nigeria and Venezuela, which together account for 1 mbpd of the cartel’s total overproduction. Despite agreement amongst many analysts that market fundamentals will tighten this year, OPEC’s apparent tolerance for creeping production increases within its own ranks could be tested if the anticipated drawdown in high global stock levels – a somewhat puzzling partner of the run-up in crude prices through 2009 – fails to materialize. It will also be wary of the potential market impact of its own rising production of Natural Gas Liquids (NGLs), which could add an extra 0.5 mbpd of supply to the market this year. Output of OPEC NGLs is not subject to quota agreements.
Furthermore NBK noted that the prospects for steady increases in both supply and demand this year provide support for those who expect oil prices to continue to trade within its current range in the short-term. Yet there remains a possibility that high inventories will affect a change in market sentiment at some stage, especially if OPEC is unwilling or unable to rein in its own crude output. If oil demand in 2010 rises at the moderate rate of 1.2 mbpd projected by the CGES – with the larger year-on-year increases front-loaded towards the first half of the year – the failure to eliminate the stock overhang could cause prices to drift lower in 2H10. Under this scenario, the price of KEC averages $74 pb in 1H10, before sliding towards the low $60s in 1Q11.
Prices could drop further and faster if the world economic recovery falters, resulting in relatively weak growth in oil demand of 0.9 mbpd this year. Again, even with OPEC crude output unchanged, a rise in non-OPEC supply and OPEC NGLs could tip the market balance. In this case, the price of KEC would begin a fairly steep descent as early as 2Q10, falling as low as $47 by the start of 2011.
The upside risk to prices comes from stronger than expected global oil demand – perhaps the 1.4 mbpd envisaged by the IEA – and weaker than expected non-OPEC supply (as a result of maturing oldl fields). Under this scenario, the price of KEC would be testing the $100 pb mark by the start of next year. It should be noted that prices at this level may well eat into oil demand in 2011, ultimately helping to push prices back down.
Ten months in, oil prices for FY2009/10 look set to average $68-70 pb, almost guaranteeing another very large budget surplus for the Kuwaiti government. Revenues for the first ten months reached KD 12.9 billion, close to double the KD 6.7 billion (pro-rated) projected in the government’s budget, which is based upon an average oil price of $35 pb. If, as we expect, public expenditures come in at 5-10% below the budget plans, the government should record a surplus of between KD 5.7 and 6.9 billion, before allocating 10% of revenues to the Reserve Fund for Future Generations (RFFG).
Next year, of course, things are open to more possibilities. In our three scenarios above, the price of KEC averages between $54 and $89 pb in FY2010/11, resulting in revenues between 31% lower and 30% higher than our projections for the current year. Yet if local media reports of a planned 35% increase in government spending for next year prove accurate, this may not guarantee a budget surplus, though we expect a surplus in both our “base” and “high” case scenarios.
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