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Can OPEC and Non OPEC Stop the Oil Price

Average daily oil production, by month, as a percentage of peak month, for OPEC and the rest of the world. Runs from Jan 2002 to Feb 2006. Believed to be all liquids. Graph is not zero-scaled. Source: EIA.

By Andrew McKillop

Since October 2006 world oil demand, as in previous years since 2002-2003 has fallen away from the Summer Demand Peak. During the July-August 2006 summer peak, world oil demand on a wide all liquids base probably hit at least 87.5 Mbd.

Prices also hit all-time nominal records, around 78 USD/bbl. This was however lower than the absolute purchasing power corrected oil price peak, attained during the 1979-1981 Oil Shock, at about 110 USD/bbl in 2006 dollars. We should note that this only concerned specific and smaller shipments, and at the time no 24-hour world oil market existed.

Pricing and settlement systems utilised in the early 1980s were not strictly comparable with current systems.

World oil demand, at least since about 2002, is now structurally variable. This structural change in the behavior of the world oil market is beginning to be recognized, and traces its origins to several key factors. These include climate change, de-industrialization in most OECD countries reducing year-round national oil demand peaks but raising summer vacation, car driving and airplane travel oil demand peaks, higher oil prices resulting in 'just-in-time' buying, reduced physical inventory capacities relative to average daily consumption - and many other smaller factors.

What is most critical for oil prices - assuring more volatility, higher peaks and deeper troughs of the oil price - is that annual demand variation inside the year profile of total demand, which is growing at about 2 Mbd-per-year, is now much bigger than annual average demand growth itself.

This can be expressed in figures:

Annual world demand growth on day average base: about 2 Mbd-per-year
Seasonal demand maximum total variation: up to + or - 2.25 Mbd to either side of average daily demand, or a total of 4.5 Mbd (troughs to peaks relative to daily average)

The question for oil market watchers and analysts is this: are the OPEC and nonOPEC supplier countries oriented to resolving this challenge to stable, predictable and remunerative prices? Alternatively, are they resigned to taking profits when seasonal demand peaks drive demand well above physical supply, resulting in price spikes, and accepting lower but volatile oil prices when demand falls, during annual troughs ?

The January 2007 oil price "crash"

This was abundantly commented by major Wall street brokerage houses, such as Lehman Bros, Bear Stearns and Merrill Lynch, and by many oil analysts. In general these US-based and US-orinted analysts focused US northeast heating oil demand. As the Chief energy economist of Lehman Bros, Ed Morse, noted in a finance radio conference, January 19, 2007, US northeast heating oil demand is at maximum about 150 Million barrels consumed through the five months October-April, for a day average of perhaps 1 Mbd. Assuming this fell by about 25% due to climate changed exceptional warmth, this would have cut US oil demand about 0.25 Mbd. US total oil demand is close to 21 Mbd, depending on season, and growing.

As Morse said, this is but "statistical noise" relative to the total of US demand - if heating oil demand fell by 0.25 Mbd this cut US oil demand by about 1.2 % for a few weeks. During 2006, we can note, US gasoline consumption increased about 3.6% over 2005. Chinese gasoil demand in 2006 increased about 17% over 2005.

However, markets react to apparent facts, and potential realities, often preferring these to 'the real thing'. In addition, Europe and much of Asia also experienced exceptional warmth for the season, also depressing their heating oil demand, and resulting in a possible fall of world oil demand relative to climate-normal of perhaps 2%-2.5% or up to 2 Mbd, in the first two weeks of January.

This was surely enough to aid downward speculators, seeking lower oil prices and profitable short selling. At the time, around 20-26 January, 2007, other commodities were also affected by the 'downwave', but interestingly enough not natural gas.

Here we have another depletion-linked factor - US natural gas supplies are, and will remain constrained by resource factors. We also have an energy price factor. Through 2005 and 2006, because of the relatively high price of heating oil and very low price of natural gas, large numbers of US consumers switched away from oil to natural gas. This in turn set a higher floor to any climate change-related falls of natural gas demand in January 2007.Natural gas prices, despite speculative attack, were much more resilient than oil prices in the January "energy price crash".

Can OPEC, Russia, Mexico, Norway, Canada and smaller suppliers balance supply/demand ?

We can be sure that world oil demand, since 2002 or 2003, is structurally variable and this variation is increasing. Conversely, however, national variations in oil demand due to seasonal factors, and economic, social and other factors (such as increasing biofuels supply) can superpose, reinforce, or cancel each other. The net result is that world oil demand variation is a "serpent de mer", an unknown or hard-to-model variable, but very surely a key oil price setting factor.

From this, we can map the Herculean Task that OPEC + NOPEC suppliers would have, if they sought perfect market equilibrium at any time in the year, assuring stable but not not volatile prices for their exports.

They would be required to bring in, and take out supply, through the year and with only a few weeks in which to operate these supply changes, of at least 2.25 - 2.5 Mbd. This would depend on the time of year, and the reinforcement-cancelling chnages of oil demand in diffrent national oil markets. They would also be constrained to continue increasing the year average supply of oil and total capacities to cover:

1. Average demand growth (about 2 - 2.2 Mbd/year net)

2. Loss of capacity from depletion (over 2.5 Mbd/year loss)

We can note that the increase of average daily world oil demand and consumption - that is demand growth - is a highly 'controversial' subject all on its own. Recent (February 2007) press statements from the OECD IEA and US EIA have tended to revise upwards previous, and low estimates for average daily oil demand growth, from about 1.6 Mbd to about 1.7 Mbd. Both these estimates are well below the real world growth of average demand, which is closer to 2 Mbd-per-year, or more.

Nether of these institutions are prepared, conversely, to give estimates on demand variation during the year. This, as we have noted, is likely at least + or - 2.25 Mbd to each side of the daily average demand number.

In turn, this is very easy to place in context relative to export volumes of major OPEC and nonOPEC suppliers of the over-130 countries in the world which import oil, from the below-30 signifcant net exporter countries. Oil demand variation on a seasonal basis is now above, or equal to net export volumes of/

Iran, Kuwait, UAE, Venezuela, Nigeria, Canada, Iraq and Angola

Very simply, neither OPEC or OPEC-nonOPEC coordination can hope to 'switch out' and 'switch in' export supplies equal to one or more of these countries, over a few weeks.

We could argue that there is however no "fatality" in this because, essentially, OPEC alone could achieve this cut. Saudi Arabia, and other suppliers, could cut their net exports by around 2.25 Mbd, then restore this net export supply, before and after world oil demand troughs and peaks in the year profile. Of course, in turn, they would need perfectly transparent data on actual physical demand in major export markets, and the political will to execute supply restructions and additions depending on time of the year.

It could be argued that just one country, Saudi Arabia, could remove 2.5 Mbd from world export supply, if Saudi rulers wanted that. Saudi Arabia + Russia could technically achieve this reduction very fast, if they wanted. Bringing in Mexico and Norway, and perhaps Canada, these massive supply variations could be considered feasible, at least on technical grounds.

Why cant OPEC and NOPEC balance out supply and demand ?

One essential pre-requisite is information.

The OPEC Secretariat has sometimes stated that it "does not recognize large or increasing world oil demand variation".

OPEC Secretariat, and key National Oil Corporations such as Iran NOC and ARAMCO continue to claim that seasonal demand variation is "unsure, uncertain and unpredictable".

Other explanations of increasing seasonal variations are preferred by OPEC officials.These include the increasing volume of oil-in-shipment trading and price setting, and uncetainty on refinery yields and refinery inventories.

This has been nuanced or slightly changed since February 2007. The OPEC Head of research, Hasan Qabazard annoucing that by mid-March 2007 world oil markets "could be oversupplied by 0.3 Mbd" (Financial site releases, week ending 15 February, 2007).

This estimate requires taking account of very large variation in world oil demand wirth season and weather trends.

However, there is presently no clear OPEC or NOPEC production policy or strategyrelative to world oil demand variation.

Another pre-requisite would be fast and coordinated export supply cuts.

As we know, when oil prices started softening in September-October 2006, OPEC did not react until November-December, with claimed or supposed "restriction of production". Many producers did not comply with this, in reality. Actual and real supply cuts were probably far below 1 Mbd.

Can we foresee a change from 'too little too late', after the January 2007 'price crash' ?

This is a spin-of-coin 50/50 choice, but 'smart money' will surely bet on no action, rather than coordinated, and in fact revolutionary changes to OPEC-nonOPEC production polices and coordinated action to fine tune net export supply.

OPEC + Russia, and possibly Norway-Canada-Mexico if prices soften much more, might decide coordinated and large supply cuts. If this occurs by March 2007 it is possible that the almost sure 'remake' of the January 2007 oil price crash can be softened or attenuated. If no action is taken, and almost certainly and surely, oil price will soften dramatically in March 2007.

The OPEC and nonOPEC suppliers can sit back and watch this, and be "price takers" if they want. Or they can act. Without action, as many oil analysts now forecast but without detailed models of world oil demand variation, March oil prices for WTI on the NYMEX may sink to 35 USD/bbl or less.

Structural undersupply by Summer 2007

Few or no analysts care to remark that by July-August 2007, world oil demand in the Summer peak can attain well over 88 Mbd on an all liquids base. This may in fact be an underestimate. Depending on national oil demand profiles and weather conditions, peak demand in Summer 2007 may go higher than 88 Mbd on an all liquids basis, that is including all hydrocarbon liquids and the biofuels, whose total supply, worldwide, now stands at about 0.4 Mbd on an oil equivalent basis (around 4.5% of world demand).

There are as ever a large number of unknowns in this forecast. Firstly, we cannot be sure that net total oil supply can attain about 88 or 88.5 Mbd by Summer 2007. This may be very close to the limit set by Peak Oil. What we can be sure of, however, is that any geopolitical incident or event, tending to cut world oil production and export supply will have a price impact that is dramatically intensified - eaxactly as in July-August 2006, when Israel's war on Lebanon was considered, by most observers, as the sole cause of record oil prices, rather than structural undersupply.

We also need to assume there is no sharp downturn in world economic growth - for example triggered by equities weakness on major stock exchanges, led by the Dow Jones Industrial Average - that significantly reduces world oil demand. Several emerging markets, notably China, may act to limit inflation overheat of their economies, for example through raising interest rates and revaluing their currencies.

We can however be reasonably sure that by Summer 2007 world oil demand can attain more than 88 Mbd on an all liquids base. We cannot be certain world supply can match this.

This makes it likely, even certain that oil prices in Summer 2007 can explosively increase, perhaps attaining more than 85 USD/barrel.

Andrew McKillop is a Senior Energy Strategist, at Juno Mother Earth Asset Management, New York. Its views are not necessarily those of PETROLEUMWORLD.

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Petroleumworld News 02/17 /07

Copyright © Andrew McKillop. All rights reserved

 

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