In its latest economic brief on the oil market and budget developments, NBK comments that after dipping in the first half of December, crude prices ended the year on a confident note, climbing back towards the record highs seen in November. The price of Kuwait Export Crude (KEC) stood at around $86 per barrel at the end of the year, up from $80.5 at the beginning of the month and moving closer to its peak of $89.0 reached on 26th November.
For 2007 as a whole, KEC averaged $66, up from $58 in 2006. Although there remains uncertainty about whether or not current highs will be sustained through 2008, modest falls would still leave Kuwait’s coffers flush with liquidity and the country’s fiscal position extremely secure. As such, the oil sector will continue to bolster the macroeconomic picture during 2008, even if – as a result of trimmed prices – its direct impact on economic growth fades.
Indeed, there could even be scope for fresh impetus with the price for lighter, sweeter crude set to re-test the psychologically significant $100 mark at the start of the year. The price of West Texas Intermediate (WTI) crude increased from $89 at the end of November to $96 by the end of December, while the price of brent crude increased from $89 to $94 over the same period.
Why the swift recovery in prices so soon after they appeared to be losing momentum? Although geopolitical issues took a back seat during December, three key factors seem to have kept the market in resilient mood. First, US crude inventories have continued to fall relative to usual seasonal patterns, down 9% in the year to 21st December and raising fears over potential crude shortages in the event of a supply shock. Some analysts, however, note that part of the recent draw may be motivated by tax reasons and could be reversed in the new year.
Second, NBK notes that although evidence of a housing sector-driven economic slowdown in the US is mounting, there is uncertainty over the extent to which this will affect global oil demand. Some observers argue that the growth dynamic in other parts of the world – particularly in emerging markets - remains essentially intact. Finally, although a US economic slowdown could negatively affect the demand for oil, it may also be associated with further weakness in the US dollar, which would buffer the impact on global demand. In broader terms, few analysts expect the overall picture of tight oil market fundamentals to change any time soon, suggesting that in the short-term at least, prices are unlikely to recede far from their current highs.
Nevertheless, opinion remains divided over the likely path of incremental global oil demand during 2008. The Centre for Global Energy Studies predicts weak growth of 0.6 mbd (0.7%) on concerns about the state of the US economy and the impact of record high oil prices on the global economy. The International Energy Agency, however, sees global oil demand growing by an extremely robust 2.1 mbd (2.5%), driven by strong growth of 1.5 mbd (4.0%) from non-OECD countries and an acceleration in demand growth from 0.4 mbd (5.2%) to 0.5 mbd (5.7%) in China. Interestingly, Middle Eastern countries are expected to rival China as the bedrock of global oil demand growth, with demand rising by 0.4 mbd (6.1%) in 2008 due to increased petrochemical production, power generation, infrastructure development and fixed investment.
On the other side, NBK notes that the global supply chain has remained stretched owing to a combination of OPEC production restraint, refinery shut-ins, attacks on oil pipelines and disappointing growth in non-OPEC supplies – and these issues persisted into the final two months of the year. Despite a pre-announced commitment to increase production by 0.5 mbd to 26.8 mbd from 1st November, output of the OPEC 10 (excluding Iraq and Angola) actually fell by 0.3 mbd in November owing to maintenance work at the Zakum field in the UAE, which more than offset production increases elsewhere.
At the fringe of the cartel, things look somewhat brighter. An improved security situation helped Iraqi output increase by 278,000 bd between August and November to return to pre-war levels, while Angolan production has increased by 140,000 bd over the same period. Indeed, given that Angolan production remains nearly 100,000 bd below its newly-agreed quota of 1.9 mbd, it could rise further over coming months. Meanwhile, December saw the re-introduction of Ecuador to the cartel, which it left in 1992. With an agreed output quota of 520,000 bd, Ecuador will be OPEC’s smallest producer. Although these factors appear to suggest improved clout in OPEC’s production capacity, its decision not to increase output at its meeting in Abu Dhabi in December – despite record high crude prices - suggests that it is likely to adopt a very measured approach to any future production increases. Indeed, the cartel continues to emphasize financial speculation as a principle cause for high crude prices.
Given current tight market conditions, prices are expected to remain high throughout 1H08. Our base case forecast is for KEC to average $83 in 1Q08 and $82 in 2Q08 before easing back slightly later in the year as a result of weaker global demand and a slight build-up in inventories. But there are considerable risks either side of this central scenario. Prices could rise considerably if one or more of the following occurs: disappointing growth in non-OPEC supplies, a short-lived weather or geopolitical spike, or resilient global demand. For example, if demand growth proves to be resilient averaging 1.5% or more. For example, if demand growth proves to be resilient averaging 1.5% or more, KEC could rise steadily during 2008, possibly reaching $100 by the end of the year. On the other hand, a slowdown in the US economy inspired by weakness in the US housing market could spread to the rest of the OECD and be the catalyst that sends oil prices sharply lower, particularly if it is combined with reduced tensions at a geopolitical level. In this case, KEC could drop from $82 in 4Q07 to as low as $52 in 4Q08.
Nevertheless, NBK notes that the prospects for the government’s finances remain extremely impressive. Under our base case, the average price of KEC for the financial year 2007/08 is some $74 per barrel, or more than double the $36 assumed under the government’s ultra-conservative budget assumptions. We see oil revenues reaching KD 17.4–18.2 billion this year – or 95% of all budget revenues - compared to KD 14.5 billion in 2006/07. Meanwhile, budget expenditures are likely to under-shoot the government’s forecast of KD 11.3 billion by 5-10%, leaving an overall surplus of KD 7.7–9.1 billion before the allocation of 10% of revenues to the Reserve Fund for Future Generations. Indeed, given that the government had reported expenditures of just 38% of its budgeted expenditures for the year in the first 8 months of 2007/08 versus 40% in the previous fiscal year, our forecast for the fiscal surplus may yet prove too conservative.
