The international oil market during the last five decades has witnessed several major crises, which have taken the shape of a severe and abnormal increase or decrease in prices or a shortage or excess of supply, passively affecting the oil industry, as well as the economies of either consuming or exporting countries.
Various factors, related to politics and information, have caused these crises. The first factor has been the occurrence of a political crisis, such as war, leading to a partial interruption of supplies and, in turn, to huge price hikes.
Some of the best examples of political factors behind oil crises were the increase of prices in 1979-80 in the wake of the Iranian revolution and the Iraqi-Iranian war which followed, as well as the 1990-91 crisis resulting from the Iraqi invasion of Kuwait and the ensuing war to liberate it.
The second factor, informational, appears as a result of inaccurate information that makes decision-making difficult and therefore leads to wrong decisions, which, in turn, result in a shortage or an excess of supply and sudden sharp price hikes.
Some of the best examples of the effect of the informational factor were the sharp price dive of 1998 and the sharp price hikes of 2000.
It is worth mentioning that the price crisis of 1972-74 was caused by various factors including the October War of 1973, the increase in international demand and the then-limited production capacity. The crisis at that time was due to political and informational factors that emerged within close timeframes.
While the political reasons behind oil crises have been extensively analyzed and studied, the informational factor has been almost completely neglected, except for an article here or there, and a symposium hastily organized in Madrid last summer.
In more detail, the informational factor means the availability of information pertaining to: production; consumption; stock movement and quantity; production capacity; and anticipated economic development.
On the basis of such information, which is sometimes inaccurate, essential decisions are made, such as increases or decreases in production, or future purchases and sales, as well as decisions related to investment and use of commercial or strategic stocks, etc.
Decisions based on such information may lead to increases or decreases in prices, which are sometimes sharp and unjustified, within a short period of time. They may also result in either an excess or a shortage of supplies of crude oil or products, and affect the revenues of refineries and their utilization rates.
Such information, assumed to be correct, on which decisions were based, might be proven wrong – sometimes within only a few weeks.
It is worth mentioning that the topic of discussion here is quantitative, not qualitative information, such as the anticipated behavior of a certain country regarding production, or the expected decisions which may be taken by one or more producer(s) or consumer(s).
It should also be observed that decisions have rippling effects. When production is increased or decreased, the effect will not be limited to the period covered by the decision, but will also spill over to later periods. This will be explained later.
In a market as huge and diverse as that of petroleum, an incorrect estimate, even within acceptable limits, will have huge effects. The statistically acceptable error margin in most scientific studies is 5 percent.
As regards the oil market, the matter seems to be different. An error may not affect one side only, but may involve three aspects (supply, demand and stocks), sometimes concurrently.
An acceptable error of 5 percent may become more than 10 percent and its impact may add up each month, season or year, resulting in a distorted market that lacks the minimum level of transparency.
For instance, if we assume that estimates of oil demand and supply in a certain year are both 75mn b/d, this means that the market is stable. But an error of 5 percent in supply would result in an increase or shortfall of 375,000 b/d.
If we assume that this error in estimation is repeated for two successive years, or that this error in supply estimation is accompanied by a similar error in demand (in the opposite direction, which means doubling the error) and, at the same time, an error in stock estimation occurs, the general picture of the market supply, demand and stock status will be distorted and unrealistic, making it difficult to take a correct decision. Hence, the market would be controlled by speculators who would decide, intentionally or unintentionally, on the direction of its movements.
Errors in the oil market are not limited to forecasting, which is naturally a hypothetical process even if such forecasts are based on logical and scientific facts, but also include estimates of the previous one or two years.
For example, we evaluated the recent estimates of six renowned international oil sources. Regarding the world oil demand in 1997, the difference between two of the estimates exceeded 1.2mn b/d (one is 73.9mn b/d and the other is 72.7mn b/d).
The same sharp differences occurred with regard to supply (from OPEC and others) and stock movement. It seems that these differences become sharper when the forecasting period is closer. Stock movement estimates of 1999 ranged between a minus of 1.4mn b/d and a plus of 800,000 b/d.
Some critics tend to accuse certain parties in the oil market of lacking transparency and issuing inaccurate information and forecasts. In most cases OPEC or one more of its members or the International Energy Agency (IEA) are the targets of such accusations.
This means that such an accusation is of a political rather than a scientific nature, whether it is recognized by the accusers or not (usually not). During the Madrid conference last summer on the information crisis in the oil market, some delegates accused OPEC or some of its members of issuing inaccurate information about their production.
However, such accusers ignored (or did not know) the fact that there are obvious differences in the production estimates even of countries with a high degree of transparency like Canada and the US.
For example, the IEA estimated the production of the US in 1999 at 5.86mn b/d and that of Canada at 1.58mn b/d while respective figures from the Energy Information Administration of the US Department of Energy were 5.92mn b/d and 1.9mn b/d. Differences between the various sources become sharper when condensates and liquefied gas are added to the US production total.
It is obvious, therefore, that there are differences, sometimes sharp, in production and consumption forecasts, not only at the global level, but also at the level of states.
There is no doubt that the lack of sound information compromises the process of correct decision-making, which may, in turn, cause or contribute to an oil crisis. An example is the low-price crisis of 1998.
When OPEC countries decided in November 1997 to increase production by 2.5mn b/d to reach 27.5mn b/d, that decision did not affect the global supply and demand status, as OPEC was producing more than that quantity and it was not possible to make further production increases.
The market, however, interpreted the decision differently. Suddenly, everybody started talking about increases in supply, decreases in demand and stock surplus. The Asian economic crisis and its impact on oil demand were amplified.
When the producers started to decrease their production in March 1998, the first impression was that the market would regain its balance and that prices would increase, but this did not happen.
The market needed further decreases until the middle of 1999. Producers needed about 18 months to regain price balance (not necessarily market balance).
Then prices started to go up. At the beginning, the reason was the Y2K problem and later it was the spell of cold weather in the US at the end of January and February and the shortage of fuel oil stock.
Then the focus switched to the probable crisis in gasoline. During 2000, producers tried to alleviate the high oil price crisis through production increases.
When OPEC increased production in March, it was believed that prices would drop or collapse as a result of the large surplus in supply and the increase in the second quarter production. This did not happen.
On the contrary, OPEC increased its production in June by 700,000 b/d, then by 800,000 b/d in September, and by a further 500,000 b/d at the beginning of November.
OPEC’s total production increase reached 3.7mn b/d, or about 3mn b/d according to independent reports. If the 1mn b/d increase in non-OPEC production is added, this would mean that oil supply has increased this year by more than 3.5mn b/d. Yet, despite such production increases, some estimates claimed that stocks were lower than last year by about 500,000 b/d.
Has international demand increased by about 4.5mn b/d over the same period last year? Everybody doubts that demand has increased by even half of this amount. It is clear that, in reality, we were calculating in the dark.
What is important now for the present and future of the petroleum industry, and the future of producers and consumers, is to obtain the best information which is as close to reality as possible, to reduce the probability of error in decision-making.
This, in turn, will limit the chances of oil crises that could arise from the lack of information. There is no doubt that we should cooperate to build a database that will be as close to reality as possible.
We also need to build bridges of confidence between producers and consumers and within each group. Such bridges must be based on transparency in providing information and should eliminate the tendency to accuse others.
As consumers and producers have cooperated in reducing political hazards which affect the oil market, it is possible for them also to cooperate to create better information which will result in making the appropriate decisions and reduce the chances of oil crises.
There is no doubt that the suggestion of Prince 'Abd Allah ibn 'Abd al-'Aziz, the Crown Prince, First Deputy Prime Minister and Commander of the National Guard, to structure the relationship between producers and consumers and establish a secretariat for the Energy Forum will reduce the chances of global oil crises and increase the availability of accurate information.
(mees)
by Ibrahim al-Muhanna - The following is an article published in Forum, a newsletter of Saudi Arabia’s Ministry of Petroleum and Mineral Resources, on 19 November 2000. Dr Ibrahim al-Muhanna is Advisor to Saudi Oil Minister Ali al-Naimi.
© 2000 Mena Report (www.menareport.com)
