In its latest economic brief on the oil market and budget developments, NBK reports that the price of Kuwait export crude (KEC) continued its dramatic decline through October, falling to $59 per barrel (pb) on October 17th, its lowest level since March 2007 and down a remarkable 57% since its peak of $136 reached in early July. Huge uncertainty generated by the global financial crisis has sparked intense pessimism over the outlook for the global economy – and subsequently for the growth of oil demand - making it difficult for the market to find a comfortable floor. The crisis has also brought to a sudden end the period of intense interest in commodities as an asset class, a turnaround perhaps linked partly to liquidation of investment positions by loss-making financial institutions and other leveraged investors, and partly to the recent performance of the US dollar, which has held its ground against other major currencies. Despite the onset of a crushing bear market, however, wide divisions remain amongst market analysts over the adequacy of medium-term supply and therefore over the future course of oil prices.
Other global benchmark crudes also saw record-breaking declines through early October. The price of both West Texas Intermediate (WTI) and Brent crudes fell below the $70 pb mark for the first time in 14 months in mid-October, after recording averages of $103 and $99, respectively, through September. The price of the OPEC basket of crudes fell to $63 pb on October 16th, down from an average of $97 in September. Between the falls there was some extraordinary volatility, including a record one-day gain for WTI of $19 pb on September 21st, related to desperate buying amongst traders covering short positions ahead of the expiry of quarter-end futures contracts.
Unsurprisingly, NBK says that the past few weeks have seen analysts slash their forecasts for oil demand both for this year and for 2009, though as the news flow deteriorates, further revisions seem possible. The International Energy Agency (IEA) cut its forecast for incremental crude demand in 2008 by 0.2 million barrels per day (bpd) to 0.4 million bpd – its weakest level in 15 years – and by a deeper 0.4 million bpd to 0.7 million bpd for 2009 in light of downward revisions to global economic growth by the International Monetary Fund. The Center for Global Energy Studies (CGES) is more pessimistic still, believing that growth in oil demand will slow to just 0.2 million bpd both this year and next as the depth of the global economic crisis spreads further. The ‘contagion’ scenario was supported by news that GDP growth in China slowed to its weakest in 5 years in 3Q08, as well as by cautionary comments from major commodity producer Rio Tinto.
Amidst collapsing global economic sentiment, attention now turns to the extraordinary meeting due to take place between OPEC members on October 24th – brought forward from November in light of fast moving developments in the oil sector. The consensus view is that cartel members will call for a 1 million bpd cut in output, though hawkish Iran and Venezuela may look for more. Although some organization members – notably Saudi Arabia – will want to appear sensitive to concerns about the impact that a renewed climb in crude prices would have on a weak world economy, it will also want to avoid a large rise in stock levels that could send oil prices spiraling downwards. As it is, there are doubts that any OPEC move will have the power to arrest further price falls: even if a cut is unanimously agreed to, there is no guarantee that it will be effectively implemented, and even if it is, markets could just as well interpret a build-up in OPEC spare capacity as a further negative for oil prices.
Any move would come on top of members’ decision in September to “strictly comply” with official production allocations - effectively cutting production by 0.5 million bpd – a decision motivated by the cartel’s view that the market was already oversupplied. It was unclear, however, that the announcement had much of an immediate effect on producers’ behavior. Production of the OPEC-12 (i.e. excluding Iraq) fell by 0.2 million bpd in September, but more than half of this came by way of unplanned outages in Angola.
OPEC actions notwithstanding, short-term forces strongly point towards further weakness in oil markets, the debate is over the extent. If we take a mildly pessimistic market view of the outlook for demand as the most likely outcome – but one in which oil demand growth in key emerging markets such as the Middle East and China keeps going next year – then it would probably take deep cuts in OPEC production in order to prevent oil prices falling much further in 2009. A combination of a very modest increase of 0.2 million bpd in non-OPEC supply next year (all from a rebound in production in the Former Soviet Union) and an equally modest 0.5 million bpd cut in OPEC production in the first quarter would not prevent Brent crude prices slipping to around $64 pb, before rallying somewhat as a result of seasonal factors in 2Q09. KEC would average $57 pb in the first quarter, and remain weak in the middle of the year.
NBK notes that if demand in the emerging market economies weakens, however, there is a realistic prospect that oil prices could fall much further. This could come about, for example, as a result of a big hit to export growth in China or less expansionary budgetary policies from the oil exporting countries of the Middle East. Oil demand could see negative growth in 2009, sending Brent down to $57 in 1Q09 and to $46 in 3Q09. KEC would fall as low as $41 by the third quarter.
A rebound in crude prices, on the other hand, would almost have to be a result of deep cuts in OPEC production, which the organization would do in an attempt to establish a new price floor. One plausible scenario would involve cuts of 1.5 million bpd by 2Q09, causing Brent to bottom out at $65 in 1Q09, before rising some $20 by 3Q09. Under such a scenario, KEC would average $58 in 1Q09, before rising back up to $78 in the third quarter.
Thankfully, from the Kuwaiti government’s budget perspective, the high price of oil in the first half of the year will protect this year’s budget position from deteriorating too far irrespective of which of these likely scenarios plays out. The three cases above see KEC average between $84 and $87 for FY08/09, well above the government’s conservative assumption of $50 used in the budget. If, as has often occurred, government spending comes in 5-10% below budget (except for the KD 5 billion exceptional transfer to cover potential future liabilities in the social security fund), the FY08/09 surplus should come in at between KD 2.3 - 4.7 billion before payments to the Reserve Fund for Future Generations (RFFG) – still a very healthy position. We calculate that - excluding the cost of the one-off transfer – the break-even oil price for this year’s budget is $54 pb. Signs of crude prices falling much below that level may lead the government to adopt a less expansionary budget next year.
Budget Forecast for Fiscal Year 2008/09
Million KD, unless otherwise noted
