Oil prices were supposed to have dropped sharply at the conclusion of the war in Iraq. Right? Well, yes. But today’s oil-price deck is stacked with wild cards.
Iraqi oil production has just reached 1 million barrels a day. This represents an improvement, but it is a far cry from original government forecasts, which had planned for output to reach 1 1/2 million barrels a day by mid June, more than 2 million barrels a day by the end of July, and as much as 3 million barrels a day by year-end.
Venezuela, which, following a workers’ strike, increased oil production faster than most observers expected, has been stuck near the 2 3/4 million barrels-a-day level for the past four months, as refinery-related problems have held back oil production. Output there is some 500,000 to 600,000 barrels a day below plan.
And Nigerian oil production, which had recovered much of the 400,000 barrels a day that was disrupted from ethnic violence earlier this year, is sporadically hampered by continued local disturbances in the Niger Delta, and is estimated to be 200,000 to 300,000 barrels a day below plan.
Despite all this, excess supply is likely to result in a steep correction for oil prices, which have remained stubbornly high. However, the timing of this event keeps getting pushed out as extraordinary events — ie., the continued setbacks in Iraq, Venezuela, and Nigeria — prevent oil output from flowing at normal rates.
The slow pace of the recovery suggests that oil prices are less likely to fall hard in the near term. The average barrel price will likely be $28 in the third quarter and $26 in the fourth. But we could definitely see an $18 barrel in 2004. In fact, as events unfold, it becomes more and more likely that oil prices will decline sharply next year.
High oil prices, along with other factors, have worked to slow oil demand and stimulate incremental supply. Second-quarter oil demand was lower than expected, and demand for gasoline in the U.S. has declined in each of the past four months. European demand has also been weak, as has demand in non-Japan Asia, Korea, India, and Latin America. Jet fuel demand, meanwhile, is down worldwide.
But non-OPEC production is expected to rise by 1.2 million barrels a day in 2004, after a similar increase expected for this year. Gains are expected from Canada, the U.S., China, Malaysia, Vietnam, Thailand, Russia, Azerbaijan, Turkmenistan, Brazil, Ecuador, Denmark, Chad, Angola, Equatorial Guinea, Sudan, and South Africa.
As for OPEC, its market share projects to be less than 32 percent next year, its lowest share since 1988. And an even greater cutback in OPEC production may be required to avert a significant fall in oil prices next year if the supply outages end. If in 2004 Iraqi production averages 2.5 million barrels a day, Venezuela reaches its target of 3.2 million barrels, and Nigeria reaches its target of 2.2 million barrels, then the remaining eight members of OPEC would need to cut output by more than 4.1 million barrels a day. But nearly all of this would fall on the shoulders of Saudi Arabia, Kuwait, and the United Arab Emirates, representing a 32 percent cutback for these three OPEC members. This looks like too big an undertaking.
As the wild cards get thrown out, oil prices will drop. In fact, the oil-price deck is stacked in favor of sharp declines in 2004.
— Mr. Leuffer, CFA, is senior managing director and senior energy analyst for Bear Stearns & Co. Inc.