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Oil Prices Are Headed Down
The 1991 scenario will play out again.


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Extraordinary events are now holding oil prices high. The uncertainties of potential war with Iraq and the Venezuelan oil workers’ strike have put a premium on oil prices of more than $10 a barrel (the barrel price at this writing was $36.06). In addition, colder-than-normal temperatures this winter and severe storm activity in the Gulf of Mexico last fall worked to wither commercial petroleum inventories to low levels, particularly in the U.S. All these factors have helped ratchet prices upward.

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However, while oil prices are strong, underlying supply and demand fundamentals appear to be less so, and inventories may not be as low as they seem — meaning there’s a lot of oil out there and prices are set to fall. Consider the following estimates by the International Energy Agency:

— World oil demand rose only 400,000 barrels a day, or 0.5%, in 2002, despite an easy comparison with the previous year owing to weather differences and the effects of September 11. Oil demand in 2002 was only 700,000 barrels a day, or 0.9% above the 2000 level.

— Non-OPEC production rose by 1.4 million barrels a day, or 3.0%, in 2002. Growth came from countries in the OECD (Organization for Economic Cooperation and Development), the former Soviet Union, China, Asia (outside of Japan and China), Latin America, and Africa. This followed the 700,000 barrel a day, or 1.5%, increase in 2001. Since 2000, non-OPEC production has increased by 2.1 million barrels a day. Put another way, in the past two years, non-OPEC production grew three times as much as world oil demand, cutting OPEC’s market share by 7%, to 37%.

— Total OECD petroleum inventories, including government-held stocks, at year-end 2002 stood at 3.78 billion barrels, or 77 days of forward demand, in line with the 1999-2001 average. It is important to look at total inventory levels, not just reported commercial storage. The build in government strategic petroleum reserves in recent years has shifted inventories from one sector to another.

When it comes to oil prices, there continue to be significant parallels to the situation in 1991 (see my column, “Oil and Iraq“). Back then, the build-up of armed forces in the Middle East led to strong oil prices and a weak stock market. Following Desert Storm, oil prices plunged, the stock market soared, and oil stocks underperformed. There’s no reason to think that same scenario won’t play out in 2003.

— Mr. Leuffer, CFA, is senior managing director and senior energy analyst for Bear Stearns & Co. Inc.



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