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Outlook for 1999: continued downward pressure on prices Recovery timing depends on a variety of global factors, including whether producers continue to restrain production, duration and extent of Asian economic crisis, degree to which Asian crisis affects rest of world, says research firm Tom Hall PNA Reporter
What is the outlook for 1999 oil prices and when are prices likely to turn around? Ann-Louise Hittle, director of world oil for Cambridge Energy Research Associates, told Meet Alaska 1999 participants that any gains in the coming year will be limited. The simple explanation for this situation is that over supply and lack of demand in the short term are keeping downward pressure on prices.
To put the 1999 outlook in broader perspective, Hittle cited three key uncertainties in the oil market: whether or not OPEC and non-OPEC producers continue to restrain production; the duration and extent of the Asian crisis; and the degree to which the Asian crisis affects the rest of the world.
If producers remain committed to production restraints and Japan’s economic woes begin to stabilize, that will help stabilize Asian oil demand in 1999, Hittle said.
“Assuming that the current production restraint is in place in the market, remains in place at the end of 1999, then the annual average for West Texas Intermediate oil is something around $13.50 — for Alaska North Slope that is somewhere around $11.50 to $11.75,” she said. The annual average for 1998 was $14.36 for WTI, “So the annual average will be a little lower than last year because we’re starting a much lower place.”
The outlook assumes an increase in Asian oil demand of 200,000 barrels per day. If that doesn1t happen or if producers stop restraining production, Hittle said that 1999 annual average prices could drop to $9.50 to $11.50 for WTI ($8.15 to $8.25 for ANS).But, Hittle said, “If the producers decide to come together and they agree to another round of further cuts — maybe 500,000 to 1 million barrels per day — then the annual average would be $14.50 to $15.00 for WTI — $12.65 to $12.75 for ANS.” How we reached this point Hittle pointed out that since 1997, “...annual average prices have fallen to where they were in the last crisis, 1985 and 1986, and are approaching the average of 1973 — before the first price shock in 1973.”
What created the excess supply to collapse oil prices? Hittle said, “The nature of the oil industry is that development, supply, and demand unfold fairly slowly.” It takes several years to determine prospective sites, search for oil, bid for drilling access, drill exploratory wells, find the oil, develop the site and transport the oil to refineries. Meanwhile, demand fluctuates between growth and decline.
“And what has happened as we all know,” said Hittle, “in 1998 it (demand) shrank — a lot.” The industry had been developing the supply to meet what was expected to be very strong oil demand throughout Asia, and, indeed, in 1997, the first year of the Asian crisis, Asian oil demand rose 900,000 barrels per day. In 1998 however, that oil demand growth disappeared.
“In fact,” Hittle said, “total Asian oil demand in 1998 fell half a million barrels a day. It took a 1.5 million barrel a day swing factor. It went from growing almost 1 million barrels a day to collapsing 500,000 barrels a day — in one year.” She added that the effects will continue, “Because whatever growth does occur, is now going to be occurring from a lower base.”
Hittle also said that non-market forces like geopolitics can affect supply, and ultimately impact demand. “Last year the United Nations decided for geopolitical reasons to more than double the amount of oil that Iraq was allowed to export under its limited oil sales plan to over $5 billion worth of oil,” she said: “It helped pull prices down during the year.”
The end result of all these events Hittle said is “...a mismatch between supply and demand, and we’re not getting a demand side reaction to the price collapse.” Why the world isn’t buying cheap oil At first glance, consuming more oil at cheaper prices would appear to be a natural marketplace occurrence. That may be true in the United States, but Hittle said there are three reasons why that doesn’t hold true in the rest of the world.
Taxes in regions like Europe, where gasoline is $5 per gallon, prevent consumers from responding to the effects of lower crude oil prices. Then there have been structural changes in the natural gas market. For example, combined cycle technology, which uses natural gas to drive electricity generating turbines, is growing. And local currencies in Asia plunged so far that falling oil prices had no effect on the domestic consumer.
Hittle said world oil demand growth in 1999 is projected to be about 1 million barrels per day compared with only 300,000 barrels per day in 1998. That projection assumes several factors such as stabilization in Japan, no worsening of the situation in China, and U.S. economic growth of 2.2 percent. Restoring the balance “Restoring balance in this market is going to depend on a supply side response, and initially that response is not in place,” Hittle said. The current imbalance is so large, she said, “that for 1999 and 2000 we’re still at significant downside price risk until we can have enough of an effect on capacity.” Because crude oil inventories are approaching capacity in the United States and Europe, it becomes a matter of logistics, she said.
Total capacity of crude oil inventories in the United States is 380 to 400 million barrels and Hittle said that in the spring of 1998, “We were nudging up against capacity for crude oil inventories in the U.S. As we go into 1999 we’re still at very high levels and there’s not a lot of leeway to absorb gains and inventories through the year.” Europe is the same way. If there is nowhere to put the excess supply, then the only answer is to stop the supply. “Of course,” said Hittle, “the only way to stop the supply is to make it uneconomical to produce the oil.”
However, uneconomic means different things to different producers because the costs for producing a barrel of oil vary. For example, if WTI fell to $9 per barrel (about $7.25 for ANS), Hittle said, “You would start to have some uneconomic production because you have to factor in the lower price for heavy crude.” However, it costs other countries, most notably Saudi Arabia, much less to produce oil. “That,” said Hittle, “is the risk to the downside of this market and it’s really defined by OPEC restraint.” OPEC’s intentions should become clearer after they meet on March 23 and decide whether to roll over production restraints to the second half of the year, she said.
Despite a sharp downward trend in Cambridge Energy’s outlook for capacity in 1999, it’s not enough in the short term. “There’s too much excess capacity in the market,” said Hittle. For the year 2000, though, Hittle’s group has cut 6 million barrels a day from their outlook for capacity. “This really gets you three possible paths — if the industry reduces its spending — on how we could see a restoration of balance in this market,” she said.
The first path assumes that if average prices remain between $11 and $14 per barrel for WTI in 1999 and 2000, then lower upstream spending would slow the growth of productive capacity. And as oil demand growth begins to recover in Asia, Hittle said, “We could see a tightening of balance between capacity for production and demand by 2001 to 2002.”
The second path would be if producer countries lifted their production restraints. Prices would collapse to single digits. “If that happens,” said Hittle, “then the obvious effects to upstream spending would be much stronger and we would see the market’s return to balance somewhere possibly as soon as late 2000.”
A third outcome is that the industry becomes more efficient at operating at lower prices. If that happened, Hittle said it would eventually stall a “significant and strong price recovery.”
Hittle predicted that ultimately, even without production restraints, capacity could be cut enough to support prices by late 2000 or 2001 to 2002. “The exact time is going to depend on industry reaction to low oil prices … and how low oil prices go in the interim,” she said.
For further information contact Hittle at 617 441-2623 or go to Cambridge Energy’s web site on the Internet at http://www.cera.com.
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