In its latest economic brief on the oil market and budget developments, NBK reports that, crude prices staged a significant rally through March, as the more intense negative investor sentiment seen at the beginning of the year dissipated, and global policy authorities took ever bolder steps to address weaknesses in their economies. The price of Kuwait Export Crude (KEC) rallied from a low of $37.2 per barrel (pb) in mid-February to $50.9 on 3rd April, its highest since mid-November. Firmer prices were supported by signs that the recent build-up in US crude inventories – which has seen stock levels reach 15 year highs – may be slowing, signaling that the cyclical low-point for US crude demand may not be far off. The OPEC cartel, meanwhile, after leaving its production quotas unchanged in March, seems increasingly prepared to allow prices to remain temporarily below what it perceives to be their ‘fair value’ of $75. That move may help to cap any further gains in crude prices through the summer.
Other benchmark crude prices also shared in the March rally. The price of West Texas Intermediate (WTI) surged back above the $50 pb mark in late March, reaching a peak of $54.3 pb on March 26, while the price of Brent crude reached $52 on the same day. Prices had settled back around the $50 pb mark in early April. In general terms, crude prices have rallied in the region of 40-60% from their lows of late December, though are still well down from where they were a year ago. Crude futures have also become a degree more bullish over the past month or so. After trading close to the $65 pb mark for much of this year, the December 2012 light crude contract, for example, has moved into the $70-75 pb range since mid-March. It is also worth noting that the shortage of storage capacity at Cushing in the US – which had pushed WTI prices below KEC prices in January and February – appears to have eased, causing more traditional positive spreads between WTI and other benchmarks to re-emerge.
Despite the somewhat more optimistic tone in oil markets, NBK noticed that analysts continue to revise down their forecasts for global oil demand growth in 2009. The International Energy Agency (IEA), for example, has cut its forecast for oil demand growth in 2009 by a further 0.3 million barrels per day (mbpd) to -1.3 mbpd (-1.5% y/y). This is the IEA’s 7th consecutive downward revision to demand prospects for the year. Even OPEC now expects demand to fall by a little over 1 mbpd, larger than the 0.6 mbpd drop projected just a month ago. The Centre for Global Energy Studies (CGES) – which had steadfastly offered amongst the direst of demand forecasts – now finds itself the least pessimistic, forecasting a fall in demand of 900,000 bpd in 2009. The bulk of analysts’ downward revisions are being driven by changes in the outlook for the non-OECD countries. OPEC notes that because of spillover from the global economic downturn, China, the Middle East and other Asian countries are “no longer the initiators of high growth to world oil demand.”
On the other hand, NBK says that the news on the supply side is more bullish. Despite OPEC divisions concerning production strategy, OPEC continues to press ahead with its massive pre-announced quota cuts, which are aimed at reducing OPEC-11 crude supplies by 4.2 mbpd from September 2008 levels. Latest unofficial data show that 3.3 mbpd (80%) of the cuts had already taken place by February, with 1.5 mbpd of those coming from lynchpin producer Saudi Arabia. Indeed, the Kingdom appears to be the one country producing below its quota-compliant levels, emphasizing the key role that it is likely to play in holding the cartel’s production strategy together. Beyond OPEC policy measures, the view that the current economic crisis is leading to a reduction in investment plans in the oil sector and, therefore, pushing the long-term price of oil above current levels is gaining ground, including through distress-noises from major oil producing companies themselves. Such pressures could conceivably translate into an upward-shift in oil prices in the near future.
With global oil demand forecasts being revised down from already low levels, the outlook for oil market balances pivots mostly around projections for the supply response. Indeed, since non-OPEC supply is expected to rise only modestly this year – by perhaps 0.1 mbpd (excluding the ‘boost’ to non-OPEC production from the inclusion of Indonesian output in the figures) - the supply response will likely reflect decisions taken by OPEC and the degree of compliance by its member states. But despite a fall in demand of close to 1 mbpd in 2009 and the prospect of very little increase in non-OPEC supply, OPEC’s already aggressive production cuts mean that it may have to do very little from here on in order to put a floor under prices. Indeed, even without implementing the remaining parts of its pre-announced production cuts, crude prices could still drift higher as the demand profile improves, quarter-by-quarter. Under such a scenario, we could see the price of KEC climbing steadily from and average of $41 in 1Q09 to around $53 by early 2010, averaging $49 for FY2009/10 overall.
If, however, OPEC manages to achieve full compliance with its proposed quota cuts, this would withdraw an extra 700,000 bpd of crude from the market, tightening commercial balances considerably. Such a situation could come about, for example, if lower-than budgeted oil prices threaten the viability of OPEC member governments’ spending plans, pushing the organization to adopt a stricter line. In that case, the price of KEC could climb significantly later this year, ending back up above $70 by 1Q10.
NBK added that, demand through 2009 could of course turn out to be even weaker than the near 1 mbpd fall assumed above, particularly if policy responses around the world turn out to be less effective than hoped in tackling the global crisis. In a more pessimistic scenario, demand falls by 1.4 mbpd, pushing the price of KEC down to its recently-visited lows of $32 by 4Q09 and seeing it average $37 for FY2009/10 as a whole.
Most of these scenarios translate into a relatively benign outlook for the Kuwaiti government’s budget finances. The price of KEC averaged $78.5 pb in FY2008/09, and we expect this to have produced government revenues of approximately KD 19.9 billion, up 11% on the year before. Although final spending numbers will not be released for some time, we see the FY2008/09 budget recording a surplus ranging between KD2.9 and 3.6 billion before allocating 10% of revenues to the Reserve Fund for Future Generations (RFFG). This figure is after deducting exceptional transfers of KD 5.5 billion to the Public Institution for Social Security (without it, the estimated surplus would be around KD8.4-9.1 billion).
For FY2009/10, the above scenarios suggest that the price of KEC could average $37 to $62 pb, 21%-54% lower than in FY2008/09, resulting in correspondingly weaker oil revenues. Based upon the government’s recently approved budget, but assuming that typically spending ultimately comes in 5-10% below plan, Kuwait’s budget balance could range between a KD2.5 billion deficit to a KD4.5 billion surplus next year (before payments of 10% of all revenues to the RFFG).
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