Oil prices hit two-year low on economic concerns

Nov 01, 2001 01:00 AM

Crude oil producers had a scary Halloween, with prices down to a new two- year low as US GDP fell in the third quarter for the first time since early 1993. Prices dropped in late September and through October, amid concern that the US might fall into a deep recession, pulling the rest of the world with it and severely depressing demand for oil. Brent Blend closed at $ 19.73/b on October 31st, down 36.5 % since September 11th's brief high of $ 31.05/b.
However, the Economist Intelligence Unit is forecasting a slight recovery in prices in the fourth quarter as demand picks up, driven by the traditional northern hemisphere winter. Thus, assuming no disruption to oil supply, Brent Blend will average $ 23.1/b in the fourth quarter of 2001, before falling back to average $ 21.51/b in 2002 and then inching down through to 2005 as the market remains plagued by persistent oversupply.

The focus of events leading up to OPEC's next official meeting, will be to try and get 'free-riding' non-OPEC producers to cut production. Venezuela's president, Hugo Chavez, toured some of the big non-OPEC producers in October asking for cooperation against falling prices.
He called for a 1 mm bpd cut in OPEC production, with the proviso that non-OPEC producers follow suit. To emphasise this, he categorically threatened non-OPEC producers, claiming that (in October) OPEC has around 4.5 mm bpd of spare capacity which it would release onto the market if non-OPEC producers did not help, which he claimed would send prices crashing down to around $ 5/b.
Although OPEC will continue to raise pressure on non-OPEC producers to curtail their crude oil supplies, we do not think at this stage that such pressure will be very effective. The October 29th meeting between the key OPEC and non-OPEC oil producing nations resulted in 'positive noises', but nothing tangible concerning cuts.
Only Oman, which became the first non-cartel member to cooperate, offered to support the next cut. However, key non-OPEC players, Mexico, Russia and Norway are currently resistant to curbing oil production. Einar Steensnaes, Norway's petroleum and energy minister, stated on October 31st that his country would not be cutting output.

Indeed, the key to the oil supply side is, as always, OPEC. Over the past couple of years, OPEC has achieved a new and remarkable unity, helped by sustained (if recently slackening) growth in oil demand. The extent to which it manages to maintain this in a gloomier world economy will largely determine the direction of prices.
So far, OPEC's cautious response has been to keep the situation under review. At its September 26th meeting, when the price of its basket of crude's had fallen below the target $ 22- 28/b range, it decided to leave quotas unchanged -- probably because the third of 2001's three cuts had only just come into effect -- and it agreed to meet again on November 14th.
Some OPEC members met again on October 7th, by which time OPEC's basket price had been under $ 22/b for ten consecutive days, which should trigger cuts under OPEC's price band mechanism. OPEC decided not to cut production: It does not want to act until it sees what effects the US bombing in Afghanistan will have on prices, nor does it want to damage unnecessarily the already ailing global economy.

Such OPEC restraint has continued, with the core focus within OPEC being greater adherence to its September 1st quotas. OPEC overproduced by around 1.3 mm bpd in September, tightening to about 0.6 mm bpd in October. Balancing supply with slack demand is undoubtedly more difficult for OPEC than keeping up with the needs of a rising market, especially as OPEC accounts for only two-fifths of global supply; and rumours of cheating had been circulating before September 11th.
For the time being, however, we hold to our base case scenario, in which OPEC seeks to adjust production whichever way it has to in order to maintain what it regards as a reasonable price level. This implies a reduction in OPEC crude output of 2.1 %in 2001, but we expect it to become more difficult to maintain control in the following two years as growth in demand for oil slackens.
A combination of restraint on the part of OPEC and disruptions to Iraqi supply will lead to a stagnation in global crude supplies, up 0.1 % in 2001. Responding to revived demand, we expect global supply to rise by 0.8 % in 2002, accelerating to 2.2 % in 2003, with increased output in Russia and Angola.

We foresee a continued oversupply of oil, despite the best efforts of OPEC, through to 2005, maintaining negative pricing pressures. Thus, dated Brent Blend will average $ 25.42/b in 2001, down 10.8 % on 2000, as dark clouds build across the global economy. Prices will continue to inch down to $ 19.64/b in 2005 as oversupply persists through to 2005.
This suggests that OPEC will be forced to downgrade its target price range some time during 2002-03.

Oil:
prices 2001 2002 2003 2004 2005 2006
Prices (a) 25.42 21.51 20.54 19.97 19.64 19.96
(a) Dated Brent Blend; $ /barrel.

Source: Economist Intelligence Unit
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