OPEC policies will ensure oil price volatility
Oil prices in 2008 could fluctuate widely as in 2007 when Brent traded between $50 and $100.
Opec officials meeting this week in Vienna blame speculators for most of this volatility. But growing price volatility stems directly from Opec’s increased importance in balancing markets. Speculative flows accentuate price movements, but the producer group is their prime cause.
Three factors reinforce Opec’s role in price volatility. The first stems from Opec’s increased internal factionalism and the politics of consensual decision-making. The second reflects Opec’s greater prominence in incremental global oil supply. The third is Opec’s own demand growth where summer consumption undermines oil production schedules, tightening markets just as demand seasonally peaks elsewhere.
Opec’s politics cloud markets by obfuscating how much oil the producers sell and to whom. Between 1998 and 2005, the producers had common objectives. Having seen revenues plunge by more than 50 per cent between 1997 and 1998, they co-operated to cut production by 10 per cent, doubled their revenues and pushed adjustment to higher prices on others.
But as prices rose and Opec restored production the group’s common interest gave way to divergences over political issues.
In particular, Iran and Venezuela have injected anti-US and radical positions on to the agenda. And they have used Opec’s consensual decision-making to stifle production increases from those with spare capacity.
Saudi Arabia discovered this last September when its proposed 1m barrel-a-day increase was halved. In practice Saudi Arabia and others have raised their output more than that, sending supplies to countries such as China where customs reporting is inadequate. Oil supplies now move by stealth into markets that poorly manage demand. Less transparency and greater price volatility have resulted.
Heightened volatility also reflects Opec’s growing centrality as market balancer. Until recently, non-Opec satisfied 80 per cent or more of global demand growth. But, last year global demand grew about 1m barrels a day and non-Opec supply met less than half. Meanwhile Opec cut supplies, causing the world to de-stock and prices to rise.
This year we estimate global demand will increase 1.4m b/d and we project non-Opec supply of just 600,000 b/d, with Opec bearing the marginal supply burden. Non-Opec’s increment, if not buoyed by non-crude sources such as natural gas liquids, may fall to zero by 2010, increasing Opec’s role as the critical swing fulcrum and introducing more price volatility.
Finally, Opec production capacity has stagnated for 30 years, with some increases offset by decreases elsewhere. When Hugo Chávez was elected president of Venezuela (1998) and Saddam Hussein presided over Iraq, the two countries could, combined, produce 6.4m b/d. Today they manage only 4.4m b/d, a loss of 2m b/d. But with more investment and a stable political environment, they could be producing double current levels.
Although Opec’s capacity may grow substantially by 2010, the producers now must confront their own high oil demand growth sparked by higher oil prices and torrid industrial and infrastructure investment. Middle East producers’ oil demand grew by 350,000 b/d last year and could see 400,000 b/d growth in 2008 despite a slowdown in global economic conditions.
Increased natural gas demand and tight supplies divert oil exports to power generation, and sap gas inputs used in crude oil production, most notably in the Arabian Gulf. Middle East countries may have lost a combined 60m barrels or more of exports last summer as a result. Current delays in regional natural gas projects look likely to make last summer’s problems even more extreme in 2008.
That would set the stage for a summer price spike, even with increased short-term Opec oil production. Any effort to cut further production now to deal with perceived market weakness as winter ends and a US potential recession unfolds will cause another rollercoaster price path in 2008. Lehman’s forecast for Brent to average $84 in 2008 may thus oscillate round a wide band of $20 or more through the year.
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