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Global oil demand is rising steadily

With oil prices hovering around $103 a barrel, the market has found its sweet spot

Global oil demand continues to rise moderately – this year it will increase by about 800,000 barrels a day (b/d), believe both the International Energy Agency (IEA) and Opec. New production, especially in North America, keeps coming on line, leaving the supplies healthy. Commercial OECD stocks are within their historical range. Things are balanced.

Opec can be content. Saudi Arabia, which has long seen $100/b oil as good deal for both producers and consumers, has little reason to mess with the status quo. The UAE’s new oil minister, Suhail Mohammad Al Mazroui, says the oil price is now “fair and suitable”. True, his counterpart from Venezuela, Rafael Ramirez, thinks Opec should be preparing to defend $100/b, but the group’s price hawks - don’t forget Iran and Algeria, Venezuela’s Opec comrades – need to sell every barrel they can. They have no spare oil to cut. This is why Opec’s big Gulf producers will ignore any pleas for supply tightening at the meeting in Vienna on 31 May.

For now, things can be kept as they are. Opec production in April was around 30.5 million b/d, or 500,000 b/d above the official target. Demand for Opec’s oil this year, believes the secretariat, will average 29.8m b/d. This is a healthy balance heading into the peak demand summer driving season in the northern hemisphere. It also gives room to Saudi Arabia and other Gulf members to tighten some supply if consumption doesn’t rise as expected in the next few months.

It would hardly be wise for Opec to meddle with the price, anyway. The market has found a range, in which the risk of demand erosion grips sentiment when prices head towards $120/b and the marginal barrel’s production costs come into play when prices threaten to slide beneath $100/b. Throw in the fiscal needs of some Opec members, whose budgets now balance only at triple-digit oil prices, and the wiggle room is small.

There are still some threats to Opec’s own production, too, even if the market seems to be ignoring these supply-side risks. Sanctions-hit Iran claims its output in March was above 3.7m b/d. Secondary sources said its production was 2.685m b/d in April. With the US Congress still baying for a tighter embargo, Iran could lose even more output.

Iraq’s descent into more sectarian strife has yet not afflicted its oil sector. Output rose again in April, to more than 3.1m b/d. But anyone counting on a rapid rise in Iraqi production should be nervous. The same is true of Libya. Despite the political chaos, its oil industry has kept output at around 1.4m b/d. But Libyan oil-industry sources are deeply sceptical about the country’s ability to keep it there. Civil strife in Nigeria is another risk.

Problems within Opec’s own members, in other words, are enough to put a floor beneath prices without talk of lopping off supply. But so, too, is the rapid inflation in production costs seen among non-Opec producers.

Bernstein, a research firm, says that the marginal cost of non-Opec output last year increased from $98.3/b to $104.5/b. Bernstein’s survey of 50 international oil companies found a new paradox in the industry, with implications for prices: the extra oil is not bringing prices down, because “cost inflation continues to rise and as commodity prices are "capped" by rising supply, net income margins in the sector are now at the lowest in a decade”. This is not sustainable, the analysts concluded. “Either prices must rise or costs must fall.”

In other words, the new liquids output from North America’s Bakken, Eagle Ford and oil-sands plays may, in the IEA’s words, constitute a “supply shock” that will transform energy markets. But the price impact can only be limited. Without oil prices above $100/b, producers cannot sell these new marginal barrels profitably.

As long as these supplies keep reaching a market in which demand is rising only moderately (at about half the pre-financial-crisis pace of growth), they will begin to steal consumers away from established exporters. In the US, Bakken’s light oil has diminished the need for West Africa’s. Nigeria and Angola between them sent 453,000 b/d to the US in February. In 2007, they sent about 2m b/d. Nigeria’s oil minister, Diezani Alison-Madueke, rumoured to be a future secretary-general of Opec, fears that new US supplies could slash African producers’ oil income by a quarter.

If Opec were the united organisation it claims to be, and if its spare capacity were spread evenly across the group, it could tame the shale- and tight-oil producers, by uncorking its own flow of extra oil and pushing the higher-cost out of the market.

But those price-war days seem to be gone. The group’s big players, especially Saudi Arabia, think they have little to fear from shale oil. The kingdom’s exports to the US have remained relatively robust, above 1 million b/d. China and other Asian buyers can soak up what American drivers do not. Saudi oil minister Ali Naimi even welcomes the new supply, saying the extra barrels will be needed in Asia’s growing market.

Those differences within the group will grow more severe if the unconventional oil bonanza in North America persists or spreads to places like China. For now, though, Opec must keep things simple: meet the call on its crude and ensure stocks are healthy.

Cutting production when supply-side threats abound would only risk another price jump, hurting a fragile global economy, bringing more demand weakness and spurring non-Opec production. Oil prices have found a sweet spot. Producers in and outside Opec should hope they stay there.

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