Middle East Economic Survey

VOL. L

No 35

27-August-2007

Oil Market In 2H 2007: Fluctuations Torn Between Optimism And Pessimism

By Behrooz Baik Alizadeh

The following article was written for MEES by Behrooz Baik Alizadeh, senior oil market analyst, National Iranian Oil Company (NIOC) balizadeh@nioc.org.

OPEC and the International Energy Agency (IEA) have published their monthly reports about oil market developments. The estimates offered by these two leading bodies for the second half of 2007 are significantly different, causing ambiguities in the oil market in the short term. In its late 2006 report, OPEC estimated at 2mn b/d the increase in non-OPEC crude supply for 2007. IEA put the figure at 1.9mn b/d for the same period. However, OPEC and IEA both modified their predictions, bringing the figures to 1.4mn and 1.1mn b/d respectively.

The decline in non-OPEC’s projected oil supply could be explained by two reasons as follows:

• Angola used to be a non-OPEC oil producer, but its position switched from non-OPEC to OPEC and as a result, global oil supply and demand changed. So, its daily estimate of 200,000 barrels production growth is included in OPEC’s production growth.
   

• Oil production in non-OPEC countries hit snags due to reparation and maintenance operations, the failure to accomplish development projects, plus natural disasters and technical faults.

Downward revisions in the non-OPEC prefigured production means more dependence of consumers upon OPEC output in view of the fact that predicted growth in demand for 2007 has remained almost unchanged. OPEC had predicted an increase of 1.3mn b/d of crude for 2007 and its prediction remains the same. For its part, IEA even revised up its predicted growth in demand to 1.6mn b/d.

However, OPEC’s and IEA’s seasonal distribution of crude supply and demand for the second half of 2007 have to be scrutinized. As the following table shows, world demand for oil would be 85.58mn b/d and 87mn b/d respectively for the third and the fourth quarters of 2007, with non-OPEC producers accounting for 54.94mn b/d and 56.01mn b/d. Relying on OPEC projections, demand for the crude supply by the organization would stand at 30.64mn b/d and 30.99mn b/d for the third and the fourth quarters of 2007. On the other hand, OPEC production in the two quarters is estimated to be 30.4mn b/d and 30.5mn b/d. Consequently, the market will have to face oil shortages of 240,000 b/d and 490,000 b/d and will have to tap its stocks. Dipping into the stocks is justifiable for the last quarter, but it could raise the prices in the third quarter due to the unusual market behavior. Through 2001-05, crude reserves have fallen by 300,000 b/d during the fourth quarter of the year, but they have shown a 500,000 b/d jump during the third quarter.

OPEC and IEA Estimates About Global Oil Supply and Demand in the Second Half of 2007

IEA’s outlook for the second half of 2007 is much more critical. It has estimated the demand for OPEC crude at 31.47mn b/d for the third quarter and at 32.27mn b/d for the fourth quarter of 2007. The oil market is going to face a 1.07mn b/d and 1.77mn b/d shortage in the third and the fourth quarters of 2007 in the light of the IEA’s predictions. The agency’s pessimistic outlook is predicting more difficult days for the oil market in the second half of the year.

It is also important to note that both OPEC and IEA have applied their optimistic and pessimistic views of OPEC crude spare production. OPEC has optimistically estimated its spare production capacity at 4.5mn b/d for the last quarter of the year while IEA has pessimistically put the estimation at 1.05mn b/d. The question here is to know whey these two bodies seek to analyze the short-term future of the oil market in this way. To find a response, the following points are important to consider.

1.       Crude prices for the OPEC basket in June reached $66.77/B – the year-high. In its last gathering, OPEC (without Iraq and Angola) had pledged to reduce its daily output by 1.7mn b/d to 25.8mn b/d. But the figures released for June 2007 indicate that 10 members of the cartel have kept only 860,000 b/d of its promised daily reduction of production. In total, 12 OPEC members have been offering 30.2mn b/d of crude.

2.       Tasked with protecting the interests of its 26 consumer members, the IEA has tried hard to halt the upward trend of crude prices. Leaning towards global figures about crude supply and demand, the IEA intends to prove to the world that demand for OPEC crude is much higher and that OPEC has to raise its production in order to make up for shortages in the market. That is where the IEA’s pessimistic view of the market takes shape. The IEA even believes that OPEC’s spare production capacity has drastically decreased and its member countries should increase their investment in order to build up more spare capacity. Such an analysis might cause anxieties in the oil market and drive up the prices, but it would also apply political pressure on OPEC producers. Another objective pursued by the IEA is to convince OPEC to add to its current production to prevent stock draw down and stave off possible shortages in the future.

3.       OPEC, charged with management of the crude market, is under political pressure from the IEA and other consumers. It is now facing difficult conditions. If OPEC announces its desire to increase its production, prices would be impacted psychologically while it does not have the necessary capacity to lift its output. Making the second issue public could also push prices up, and then the consumers would ratchet up the pressure on the OPEC. Any failure of OPEC to manage the market at a time of rising prices would mean its loss of influence on the international oil market and no OPEC member favors such conditions. That is why OPEC has decided to calm the market and its optimistic analysis is the proof. Therefore OPEC pretends that it would be able to compensate for any sudden change in the market in the last quarter of the year and its relevant officials do not cease to say that the market is supplied with enough crude.

4.       The market will fluctuate between the predictions of OPEC and IEA. Anyhow, the prices will be consolidated in the second half of the year. One should not forget the point that downstream bottlenecks as well as geopolitical tensions and crises have contributed to higher prices. Prices will go on an upward trend if the supporters of high crude prices are magnified by their media. Such a trend could bring more revenues for producers. Many OPEC members are well informed of the point that secondary sources estimate their production lower than its real level. The real production reflects the decline in the spare capacity of OPEC. Once the market knows of this fact, it can facilitate the upward trend of prices.

References

1.       Monthly Oil Market Report, OPEC, June, 2007.

2.       Oil Market Report, IEA, June, 2007.

3.       PIW, June 25, 2007.

4.       Reuters May-June 2007.