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In its latest economic brief on the oil market and budget developments, NBK noted that, after falling sharply in the second half of January, crude oil prices have since recovered most of their lost ground. The price of Kuwait Export Crude (KEC) rose from a low of $67.9 per barrel (pb) in early February to $75.0 pb at the start of March, closer to the 15-month high of $80.3 recorded in mid-January. The rebound was partly momentum driven, with traders unwilling to push crude prices too far below their recent $70-80 pb range. Higher prices may also have reflected heightened tension over the outlook for key currencies and government bonds – generated chiefly by fears of Greece’s recent debt woes – which encouraged a flight to ‘real’ assets, including crude oil. Other analysts cited support for crude from the imminent arrival of the spring driving season in the US, as gasoline companies build inventories and switch to more expensive, cleaner burning fuels.
Global benchmark crudes enjoyed a similarly sizeable rally in the second half of February. West Texas Intermediate (WTI) returned to above the $80 pb mark in early March, shrugging off USD strength and news of above-consensus rises in US crude inventories. Brent meanwhile, trod a more volatile path before ending February at $76.1 pb, up 9% from its recent low.
As has been the case in recent months, the discount of spot versus futures prices – which had been as large as $30 pb a year ago for contracts set to expire at the end of 2012 – has continued to narrow. Some analysts believe that spot prices may soon revert to being worth more than near-dated futures contracts over coming months – a traditional sign that supply and demand fundamentals are tightening. It also suggests that – in the view of futures market participants at least – the current price of oil is broadly sustainable over the medium-term.
Recent trends have largely supported the notion of fairly robust recovery for global oil demand in 2010. One factor has been the protracted spell of cold weather in the northern hemisphere, which has boosted demand for heating fuel. The Centre for Global Energy Studies (CGES) made a third successive monthly revision to its demand outlook, leaving incremental oil demand in 2010 at 1.3 million barrels per day (mbpd, or 1.7%), up from 1.2 mbpd a month earlier. They continue to emphasize, however, the scope for year-on-year changes to decelerate through 2010, as the extreme weakness of early 2009 falls out of the annual comparison. Similarly, the International Energy Agency (IEA) increased its already bullish forecast from 1.4 mbpd (1.7%) to 1.6 mbpd (1.8%). The latter relies on upbeat assessments for world growth from the International Monetary Fund. Even this, it says, factors in an ‘oil-less’ recovery in output from within the OECD, partly the result of rising competition from cheap spot natural gas this year.
According to figures published by OPEC, crude output of the OPEC-11 (i.e. excluding Iraq) recorded its tenth consecutive monthly increase in January, rising by 148,000 bpd to stand at 26.799 mbpd. Production has now risen by nearly 1.1 mbpd from its low in March 2009. Moreover, the pace of increase stepped up in January, with the monthly rise the largest since May. Although Nigerian output fell by a sizeable 124,000 bpd, this was more than offset by increases of 133,000 bpd and 105,000 bpd in Angola and Venezuela, respectively. If it were to remain at this level throughout the year, OPEC-11 crude output would end up 572,000 bpd higher than in 2009. In addition, the organization expects production of Natural Gas Liquids (NGLs) by its members to rise by 0.5 mbpd (10%). Interestingly, this huge ‘shadow’ increase in OPEC oil supplies could take place without any formal change in its official production quotas.
While there appears to be considerable support for oil prices near current levels, the prospect of significant supply growth this year still leaves scope for the market to weaken later on. Even if OPEC leaves its crude output unchanged at current levels, growth in OPEC NGLs and an anticipated 0.3 mbpd increase in non-OPEC supplies would see total oil supplies rise by around 1.3 mbpd in 2010 – more or less the same as the increase in global oil demand forecast by the CGES. However, with demand only rising from its weak 2009 base, stock cover would remain high and provide an impetus for prices to fall back around the middle of the year. In this scenario, the price of KEC falls steadily in the second half of 2010, reaching around $60 pb in 1Q11.
NBK noticed that additional supplies of non-OPEC oil could push prices even lower, however. Significant projects in Brazil, the US, Canada, Ghana and Australia are all due to come on stream this year. If these can contribute an extra 0.2 mbpd in 2010 – taking growth in non-OPEC production to 0.5 mbpd – the drop in crude prices expected in 2H10 could be larger. In this case, the price of KEC could fall to $64 pb in 3Q10 and be in the $50-55 range by the start of 2011. Note, however, that prompt action by OPEC to withdraw some of its supplies from the market could alleviate this downward pressure.
More bullish analysts, on the other hand, see benchmark crude prices as set to make a sustained break into the $80-90 pb range from the $70-80 pb range seen in recent months. For them, 2010 marks a ‘transition’ year that sees demand recover before global supply shortages begin to bite again in 2011. Under this scenario, with demand expanding by the 1.6 mbpd forecast by the IEA, the price of KEC rises steadily throughout the year, reaching $83 pb by 1Q11.
With the 2009/10 fiscal year drawing to a close, the price of KEC looks set to average around $69 pb, down 13% on a year ago but still almost double the $35 pb assumed by the government in its budget. Another large fiscal surplus looks essentially guaranteed. If, as we expect, public expenditures come in at 5-10% below the budget plans, the surplus should be between KD6.2 and 7.1 billion before allocating 10% of revenues to the Reserve Fund for Future Generations (RFFG). This would be the second or third largest in Kuwait’s history and equate to around 20% of 2009 GDP.
In FY2010/11, the average crude prices outlined in the scenarios above – at between $61 and $80 pb – leave open a wide range of possibilities. Revenues would turn out between 20% lower and 11% higher than our projections for the current year. Meanwhile, according to the government’s preliminary budget, public spending is set to rise by 33% above FY09/10 budget, partly as a result of outlays on the 4-year KD31 billion development plan. This plan will provide a large and timely boost to the economy. The government estimates a deficit of KD6.4 billion in FY2010/11 (before RFFG allocations). This is based upon a conservative assumption for the price of KEC, at $43 pb. Based upon our own scenarios, the budget could still register a sizable surplus.