OPEC's DECISION to boost production by 800,000b/d is unlikely to bring prices down to the $25 a barrel target that would supposedly satisfy both OPEC and the oil consuming countries.
Oil prices in the past have been sensitive to output increases, however, the supply adjustment have only provided temporary relief during periods of strong world economic growth. Oil prices are likely to continue to trade above $28 a barrel in the foreseeable future.
Low gasoline stocks in the US and Europe are pushing refineries to favour gasoline production at the expense of heating oil. Last winter, heating oil stocks were already at a 10-year low. This winter, American and European deficits will be 50 per cent and 20 per cent worse, respectively, and this will put more pressure on the already surging heating oil prices.
The upturn in energy prices can really be traced back to early 1999 and the cyclical recovery of the world economy in the wake of the Asian and Russian crises. With global real GDP growth expected to reach 4.5-5 per cent this year, before slowing to 3-4 per cent in 2001 (still slightly above the long-term trend), demand of oil is expected to remain strong for the foreseeable future.
Hence barring a hard landing in the US or another crisis in the international economy, OPEC's production increases are likely to do little more than slow the rate of expansion. So far this year, OPEC increased its production by 2.16mb/d without having much impact on oil prices. On June 21 this year, OPEC agreed to boost its production by 708,000b/d effective July 1. This followed the earlier 1.452mb/d increase agreed to in March 27.
Concerns that the past two quota adjustments would not be sufficient to lower prices significantly led Saudi Arabia to announce on July 3 that it wanted to bring the OPEC basket price down to $25 per barrel and that it will be increasing its production by an additional 500,000b/d.
It is not clear whether the latest increase in OPEC's production of 800,000b/d includes the extra Saudi output which is already in the market. Most probably it does, which implies a net increase in production of 500,000b/d effective Oct. 1, 2000 assuming the actual increase in Saudi production is 300,000b/d.
Global oil demand is expected to average 77.7mb/d in 2000, an increase of 1.7mb/d (2.2 per cent) over 1999, with strong economic growth ameliorating the negative impact of higher oil prices.
The largest increase is expected to come from Asia / Pacific at 600,000b/d, as economic growth there continues to gain momentum. This will be followed by North America at 200,000b/d, way below the 500,000b/d increase recorded in 1999.
Because of the lower tax burden in the US compared to Europe (see table), higher oil prices are passed on to American consumers much more quickly than to their counterparties in Europe and Japan.
Global oil demand is forecast to further increase by 1.87mb/d in 2001, with the continuation of the up cycle in world economic growth holding well into next year.
On the supply side, non-OPEC production is expected to rise by 670,000b/d, averaging 46.6mb/d for 2000. Most of the increase will come from Canada, Mexico and the UK which will contribute 130,000b/d, 140,000b/d and 160,000b/d respectively.
OPEC's current crude oil production capacity is put at 32.1mb/d and with average production in the second quarter this year of 27.8mb/d, the organisation's spare capacity would be 4.3mb/d. Most of the excess capacity is in Saudi Arabia at 2.4mb/d and to a lesser extent in Kuwait (0.6mb/d) and UAE (0.8mb/d). OPEC does not appear to have a problem meeting likely demand growth for its oil during the next couple of years, but could struggle to make up volumes in the event of a crisis interrupting flows from a large producer.
While the importance of oil to the global economy has declined dramatically in the last 30 years, world demand will continue to grow at the average rate of 2 per cent annually putting upward pressure on oil prices and on the need to expand production capacity mainly from the Arab Gulf.
About a third less oil was used to produce an average unit of GDP last year than in the early 1970s. In the past five years, real world GDP was up by more than 20 per cent while oil consumption increased by only 9 per cent.
The sharp drop in oil-dependency began after the price shock of 1973. Over the next decade, the global ratio of oil-demand to GDP fell by 20 per cent. Oil-demand diminished less drastically in the late 1980s, but it has dropped steadily since the Gulf war. Despite oil's smaller role, there is still untapped demand.
Asia's emerging economies consumed only 1.4 barrels a person last year; in Latin America, usage per person was 4.1 barrels. By contrast, America used nearly 25 barrels a head last year, and most other big economies topped ten barrels (see chart). As car ownership in the developing world increases, so will demand for oil.
The additional OPEC production of 800,000b/d will not be enough to cool down prices, moreover the extra oil won't reach the market until mid November.
By then winter demand will spike requiring OPEC to consider boosting production again when they next meet on Nov. 12, otherwise prices will continue to trade close to $30.
( Jordan Times )
Henry T. Azzam Chief Economist and Managing Director,
Middle East Capital Group
© 2000 Mena Report (www.menareport.com)
