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February
27, 2003, 8:00 a.m.
Oil
Prices Are Headed Down
The 1991 scenario
will play out again.
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 xtraordinary
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.
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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