As oil prices get shaky, global demand weakening may be offset by political tensions and Opec's firm hand
If events since the start of the year are any indication,
the energy world is heading for another roller-coaster year in 2007, though perhaps prices will not soar as high as they did last year.
Last year's ascent by oil prices to their highest level on record - when benchmark Brent futures rose to a high of $78.65 a barrel on August 8 - was not purely demand-driven, but rather a reaction to a combination of factors, including geo-political tension in the Middle East, disruption to production in Nigeria and to a pipeline leak in Alaska, which slashed US production and temporarily inflated demand for imported oil.
Another big factor was the injection of massive investment into commodities markets by pension funds and institutional investors, whose liquidation of long positions since the start of the year has since contributed to weakening oil prices.
Saudi Arabia's oil minister Ali Al Naimi said in December that there was 100 million barrels of excess stock in consuming countries that needed to be drained for markets to achieve equilibrium, and now believes that markets are moving toward balance - though they may not be there yet.
The problem facing markets today was not one of supply, he has insisted, but one of "deliverability," defined as the ability of producers to get oil to consumers who have not invested enough in the last 25 years in refineries able to process this crude.
In its latest monthly oil market report, the International
Energy Agency said much of the recent fall in oil prices was due to fundamental factors, and that Opec production restraint could paradoxically be adding to downward pressure on prices in the short term.
By cutting supply, producers end up with more spare production capacity that can be brought on in the event of a major disruption, be it the result of severe weather, violence or an accident.
In the last few weeks, oil prices have slumped further, then recovered a bit. Russia has again flexed its substantial energy clout in continuous battles with former Soviet republics over transit routes for its oil and gas, and Iran is still in US sights, a bit of geo-politics that has kept oil prices bubbling in recent years.
As for Iraq, well, 'let's not go there' seems to be the received wisdom among the major oil companies.
Looking further into 2007, tensions over Iran's nuclear programme are likely to exert some pressure over prices if the US presses for tighter United Nations sanctions against Opec's second biggest producer, and if the situation in Iraq does not improve enough to allow crude oil production capacity to rise.
The deteriorating situation in Lebanon and the stalemate
in the Israeli-Palestinian crisis sit on the margins of the oil markets, and occasionally may exert some bullish influence as fears of a larger Middle Eastern conflagration simmer in the background.
Demand and supply
The IEA now expects world oil demand to average 85.77 million bpd this year, 160,000 bpd less than previously predicted. Year-onyear demand growth is seen at 1.39 million bpd (1.6 per cent), down from an estimate of 1.43
million bpd in the previous report.
Demand projections for most regions were cut in the IEA report although the estimated average demand in 2007 in China, the world's second biggest oil user after the US, was left unchanged at 7.35 million bpd.
Retrospectively, it was the explosive surge in Chinese demand that began the cycle of higher oil prices in 2004, and it is Asia that will remain the highest demand growth area of the consuming regions.
It is worth noting that Saudi's minister Al Naimi began this year with an extended tour of India, South Korea, Japan and China, all of which import the bulk of their energy requirements from the Middle East, including liquefied natural gas (LNG) mainly from Qatar.
On the supply side, the IEA cut its estimate of non-Opec oil production this year to 52.3 million bpd (including output from new Opec member Angola), 300,000 bpd less than previously expected.
Most of the downward revision is accounted for by Norway, Mexico, Canada, Cuba and Ecuador, it said.
The change leaves expected year-on-year growth in non-Opec supply this year at 1.4 million bpd, mainly coming from Africa, the former Soviet Union and biofuels, which are expected to play a bigger part in the energy mix in the months and years ahead.
Opec
From a structural perspective, producing countries within the Organisation of Petroleum Exporting Countries (Opec), which accounts for 35 per cent of global supply, are raising their production capacity.
Saudi Arabia alone will have three million bpd of spare capacity from February, Al Naimi said in New Delhi recently.
And there is more to come. The UAE and Saudi Arabia are both expecting to bring new capacity on stream later in the year, though other producers like Iran and Venezuela will struggle to raise their production beyond current levels because of sharp decline rates in the former and the lingering impact of a strike some years back that crippled the energy industry in the latter.
Reflecting on recent trends, UAE's Minister of Energy Mohammad Bin Dha'en Al Hamili, the current Opec president, began urgent consultations with Opec ministers to see whether they needed to take further action on supply or to wait until already agreed reductions began to bite.
Ministers have made clear that their action was not determined so much by price, which they believe is a short-term phenomenon, but by the alarming rise in stocks, necessitating a pre-emptive move to stop an unseasonable stock build in the second quarter of the year, when demand traditionally falls and refineries switch to producing gasoline.
This may be good news for the likes of Opec member Nigeria and producers of the lighter type of crude like Brent Blend, the world's benchmark, but not so for Middle Eastern producers, who have to sell their oil at a discount to the lighter grades.
That discount steepens as the seasons and demand patterns shift.
This sweet-sour differential is likely to balloon further in the months ahead as the incremental barrel of crude will be mainly of the heavier, sour type produced by the majority of Middle Eastern producers.
Investment
Further, despite gradual moves by consumers toward more eco-friendly fuels, in the Saudi view fossil fuels will retain the biggest share of the energy mix in the years and decades to come, Al Naimi has argued, explaining why the kingdom is investing $80 billion to expand its production capacity to 12.5 million bpd by 2009.
Yet, such levels of investment require prices to be at a level that allows producers to bring more oil and gas out of the ground without depressing demand.
In this regard, consultants PFC Energy say high oil prices have rendered the top Opec troika of Saudi Arabia, Iran and Venezuela more resilient to external shocks than at any time in history because of the exceptional behaviour of their oil-dominated economies.
Nevertheless, Opec's top three producers remain vulnerable to any sharp fall in oil prices, PFC say. For instance, Saudi Arabia's budget breakeven is currently at around $55 a barrel for US WTI and Iran's at $60 - with both rising.
The message is that oil prices will need to stay at relatively high levels if producers are to meet their investment spending targets, though few expect the Opec basket price to rise above $70 a barrel as it did last year.
Opec has not said what price level it will defend, though remarks by senior officials and ministers suggest they would act if it fell below $50 a barrel.
As a matter of record, Opec has more often than not been successful in its interventions. According to Deutsche Bank's energy outlook, since 1993, Opec announced ten quota reductions, with a 70 per cent success rate of supporting or pushing oil prices higher in the two to three months after such action.
Only where global growth is slowing rapidly, for example in 1998 and 2001, has it been unsuccessful in defending
prices.
On that basis, if you take an upbeat view towards global growth, you might expect to see oil prices recovering above $60 a barrel. A downbeat view of the world economy, logically, would keep expectations below that level.
The writer is Middle East Editor, Platts
