latest economic brief on the oil market and budget developments, NBK
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In its latest economic brief on the oil market and budget developments, NBK reports that, after recording post-crash highs in August, crude prices slipped back in September. The price of Kuwait Export Crude (KEC) fell to a low of $62.8 per barrel (pb) on 28th September, down nearly $10 from its peak of mid-August. Some analysts interpret the latest decline as a temporary correction within a rising trend – perhaps the result of sudden offloading by floating crude tankers. These tankers had been delaying deliveries to take advantage of high futures prices.
However more fundamental factors may have played a part too. Firstly, concerns had slowly risen that – as the impact of the exceptional policy measures implemented over the past year fades - the global economic recovery (and hence recovery in the demand for oil) may be running out of steam. Secondly, following their mid-September meeting, OPEC members’ comments appeared somewhat less hawkish than of late, a possible signal that the organization is prepared to live with prices trading in a range below their ‘fair’ value of $75 per barrel (pb), at least in the near-term. Finally, still-high stock levels for some crude by-products may also be capping any upward pressure on prices.
The prices of other major global benchmark crude prices – including Brent and West Texas Intermediate (WTI) - also slipped late in September, falling $8-10 pb off their August highs to stand in the $65 – 66 pb range. Despite the intra-month fall, however, September was the fourth consecutive month that average WTI prices have stood within or close to the $65-70 pb range, marking one of its more stable periods of the past three years. It is also worth noting that the average spread between spot WTI prices and contract prices for light crude for delivery in December 2012 narrowed to below $10 pb for the first time in a year in September. This narrowing not only provides an incentive for crude suppliers to reduce inventory levels, but is a further sign that a semblance of ‘normalcy’ is returning to the market.
NBK noted that the improving economic backdrop has resulted in a significant upward revision to forecasts of world oil demand by the International Energy Agency (IEA). The IEA now expects global oil demand to contract by 1.9 million barrels per day (mbpd), or 2.2%, in 2009, a 0.5 mbpd smaller fall than forecast in August. This improvement is largely driven by stronger-than-expected outturn data for the year so far rather than a change in the organization’s expectations for the future. The IEA’s forecast – which has long been one of the more pessimistic in the market – is now much closer to those of other forecasters, such as OPEC and the Centre for Global Energy Studies (CGES), who see oil demand falling by 1.6 to 1.7 mbpd this year. Differences remain for next year, however, with the IEA expecting a much stronger rebound in demand of 1.3 mbpd (1.5%), led by North America and Asia. Others see a more modest rise of 0.5 to 0.7 mbpd.
NBK added that improving sentiment on the demand side may have encouraged OPEC to take a more relaxed attitude toward member states’ faltering compliance with production targets. Latest figures show that crude production by the OPEC-11 (i.e. excluding Iraq) stood at 26.3 mbpd in August, up 123,000 bpd from July. This implies 65% adherence to the cartel’s target of a 4.2 mbpd reduction in output from September 2008 levels, down from a peak of 79% in March. Including Iraq, OPEC production has increased by a hefty 750,000 bpd, or 3%, since March. While overproduction may have slipped down OPEC’s list of priorities for now, this could change, particularly if non-OPEC supply continues to hold up relatively well. The burden of any further OPEC tightening may fall upon already complying countries, potentially exacerbating existing divisions within the cartel. Formally at least, the next change in OPEC’s production stance is not due before the organization’s next scheduled meeting in Angola, this December.
With the prospects for world economic recovery somewhat improved, the potential for a meaningful quarter-on-quarter improvement in world oil demand has correspondingly increased. Nevertheless, the combination of a seasonal rise in OECD oil production, rising output in the Former Soviet Union and an increase in output of Natural Gas Liquids (NGLs) from within OPEC itself (NGLs are not subject to quota restrictions), all these factors may serve to cap any near-term upward pressure on prices arising from stronger demand. Accordingly, any variability in prices going forward might reasonably occur next year rather than this. Assuming that the fall in demand this year turns out close to the 1.7 mbpd envisaged by the CGES, and assuming that OPEC production remains more or less unchanged over coming months, oil prices are likely to stay close to their current range in 4Q09 and 1Q10. The price of KEC would stand at around $67 pb in 1Q10, not far from its present levels. Prices might then ease back as winter-related demand in the Northern Hemisphere wanes.
A more vigorous than expected economic recovery – perhaps resulting in oil demand growth of 1 mbpd next year - could push prices higher going into 2010. With its large (and recently-expanded) volume of spare capacity, OPEC would be capable of increasing output to meet demand. But should it choose to leave output unchanged, or simply react too late, prices could quickly strengthen to above $70 pb and continue rising through next year. Under this scenario, the price of KEC averages $66 for FY2009/10 as a whole.
On the other hand, the much-feared ‘double-dip’ recession in the world economy, even if it resulted in a modest downgrade of 2010 oil demand growth to 0.5 mbpd, could set the scene for softer oil prices next year. The fall in prices would surely be cushioned by cuts in OPEC oil output by mid-year, however. In this case, the price of KEC averages $65 pb in FY2009/10, with the bulk of the fall in prices occurring in the next fiscal year.
An average crude price of $65 to $66 pb for FY2009/10 as described above would be way above the $35 pb assumed in the government’s budget for FY09/10, and would result in a budget outcome much better than the KD 4.0 billion deficit projected by the government. Indeed, the latest official figures show budget revenues in the first five months of the year already worth 82% of the entire year’s projection in the budget. If, as expected, public expenditures come in at 5-10% below budget, we estimate that the government will end-up with a budget surplus of between KD 4.4 and 5.7 billion, before allocations of 10% of revenues to the Reserve Fund for Future Generations (RFFG). If so, this could be the government’s third largest surplus on record.