The Hindu Business Line : Crude boils over

Crude for spot delivery has also reached a 21-year high. The surge in oil prices comes at a time when the global economy just about started showing signs of a sustained recovery. The rising oil prices do not seem to be only a speculative bubble but also a symptom of shifting demand and supply equations.

In this article, we would take a look at the demand-supply situation and the likely trend in the rest of this year and next year.

Recent economic data from the US suggests that the economy may have slowed down from its earlier rate of growth and is now below the trend rate of growth. The US economy grew at 3 per cent in the second quarter of this year. Even the employment environment remains weak. Even though the European and Japanese economies show signs of sustainable growth, the global growth rate should slow down a tad to around 4.8 per cent in 2004 andto around 4.3 per cent in 2005.

A strong reason for this forecast is that US should grow at less than 4 per cent this year and should slow down to around 3.7 per cent next year. The Chinese economy should also slow down in response to the quantitative tightening measures.

Supply side dynamics

The commodities market keeps a close eye on the Organization of Petroleum Exporting Countries (OPEC) and tracks the production quotas and supplies.

However, the non-OPEC output is almost 1.75 times higher than the OPEC production. OPEC produces around 28.4 million barrels per day compared with 50.02 million barrels per day from the non-OPEC countries. OPEC used to operate on the quota system for each member country. This process was in place to ensure that optimal supply to keep the crude oil prices in the preferred price band of $22-28 a barrel. Unfortunately, most of the OPEC members are now producing oil at near capacity and Saudi Arabia is the only country with some additional capacity. Saudi Arabia is also the country with the largest oil reserves in the world. Even though OPEC tries hard to increase the supplies and is almost overlooking the quotas for now, the prices continue to move higher.

One must remember that there would be problems in running the oil production at near capacity as the schedule for maintenance and repairs would throw the average down. Any unrest or disruption in production in member countries would have a negative impact on the market. It is evident that the non-OPEC supplies have gained importance.

The halting of production by a large Russian oil company, Yukos, led to a surge in oil futures last fortnight. OPEC forecasts indicate that non-OPEC supplies should increase by around 1.34 million barrels per day in 2005, taking to the daily average production to 51.21 million barrels per day. One has to look at the demand situation for a clue on the underlying trend.

Demand side dynamics

OPEC latest estimates indicate that the world oil demand is projected to grow from 80.90 million barrels per day by around 1.67 million barrels per day to touch 82.56 million barrels per day. The significant demand increase is expected to come from China, Asia and the Americas as shown in the table.

Inventories

There seems to be steady increase in crude oil reserves, both in the on-land commercial stocks and strategic petroleum reserves in US, Europe and Japan. The average commercial on-land stock in United States is close to a 5-year average. There are also plans of creating strategic petroleum reserves in India and China, which would increase demand in 2005. The increase in inventories can at best dampen the impact of run away crude prices but it is unlikely that the main blocks would use these reserves now given that the intensity of cold weather in the coming months is unknown.

In case the weather is as cold as last year the oil demand would increase higher than projected by OPEC. OPEC forecasts builds in a moderate weather this year. The tanker rates also continues rise on tight tonnage availability and tanker demand.

Conclusion

As the world demand is projected to increase by 1.67 million barrels per day and the non-OPEC countries may contribute around 1.34 million barrels per day of increased supply next year, OPEC would have to fill in the gap. This does not withstand any supply disruptions, unpredictable gaps or change in weather predictions. It is obvious that the crude oil market is running quite tight and hence the likelihood of any significant downmove looks unlikely. Even though the economy may be slowing down in US, the energy consumption may not come off. The risk of an oil shock remains on the horizon if there is any unplanned disruption to supply. This amply justifies the frayed nerves of the crude oil futures market and why it is reacting to every piece of small news or data. This is also creating anxiety for the central bankers around the world.

(The author is Senior Manager, Corporate Treasury Sales - Western India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)

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