Opec’s oil-supply dilemma as Libyan conflict continues
Next month’s Opec meeting in Vienna is shaping up to be a humdinger
ASSUME that Libya’s conflict is still raging next month; Muammar Qadhafi is still officially in power; and production from the country still shut in. What will Opec do about the Transitional National Council (TNC), the fledgling rebel government now touring the world claiming to speak on behalf of a liberated Libya?
Qatar, an Opec member, has recognised the TNC and has even agreed to market its oil. Kuwait, another member, has pledged cash to the rebels, even if no payment has been made yet. But Opec has remained officially neutral. Shokri Ghanem, chairman of Libya’s National Oil Company, is unlikely to show up at the meeting – his status is unknown. On 17 May, he was reported to have defected and is said to be in Tunisia.
But there’s also a market problem of the kind Opec hasn’t faced in a while. Even after the sharp fall in crude futures this month, which took $14 a barrel off North Sea Brent to leave it trading at around $110/b, prices are still too high for Opec’s comfort. Sure, the group’s members get rich with high oil prices. But that’s no good if it means volatility in the price or a slowdown in global economic growth, which would in turn cool oil demand.
But Opec’s own data provide ample ground for another surge in prices. The group’s most recent market report implies that the call on Opec oil (crude and natural gas liquids [NGLs]) will jump by over 2 million barrels a day (b/d) between the second and third quarters of the year to 36.25 million b/d (see Figure 1). Those are startling numbers.
The International Energy Agency (IEA) says Opec’s April production, including NGLs, was 34.46 million b/d. So how will Opec meet what amounts to about a 5% rise in output in just three months?
Testing the limits
Expecting Saudi Arabia – which accounts for most of the group’s spare production capacity, estimated by the IEA at 4.14 million b/d – to lift its output to more than 10 million b/d begs credibility. Between them, the UAE, Kuwait, Angola and a couple of other producers may cobble together some of this, perhaps 600,000 b/d. But that would also be testing the limits (see Table 1).
The IEA’s outlook for the call on Opec is a little more sedate, seeing it rise by 900,000 b/d between Q2 and Q3, to 35.91 million b/d.
So Opec must decide whether it trusts forecasts from the IEA, which sees signs of demand-growth erosion as a result of high oil prices, or its own predictions.
And if Opec really believes its own demand outlook, it will have to raise its output quotas and signal to the market that it will meet the rising call on its crude. This would show that it also believes, as secretary-general Abdalla El-Badri put it to Petroleum Economist in February, that the “great recession is over”.
The risks of this strategy to Opec are plain. As the IEA wrote in its latest monthly Oil Market Report, “persistently high prices at this stage of the economic cycle” – while the recovery remains fragile – “may ultimately sow the seeds of their own destruction”.
But there’s more to this than the old adage that the cure for high prices is high prices.
Oil-demand erosion is bad news for producers because the lost consumption tends to disappear forever. The demand recovery since 2008 didn’t come from anyone who sold their SUV in 2008 deciding to buy a new one now. It has come, almost entirely, from economic growth in Asia, where Chinese oil demand continues to underpin producer confidence.
That’s the conundrum for Opec. The demand forecasts for the next two quarters give ample reason for prices to spike still higher. But already, says the IEA, oil consumption is slowing in response to the recent market surge. So another spike now will speed up the trend, perhaps even dampening economic and oil-demand growth in China, where worries about inflation persist. Indeed, the Chinese government has just banned diesel exports – a sign that it, too, is concerned about the market’s tightening.
And then there’s the other problem posed by Libya. The volume of oil lost from Libya has almost all been replaced. But the quality of it has not (PE 5/11 p2). This isn’t an upstream problem so much as a downstream one. The small, European refineries that depended on Libya’s light, sweet, paraffin-rich crude haven’t managed to switch to heavier oils.
Saudi Arabia promised a replacement blend that would suit the refiners’ tastes. But it has only partially worked. Some of the cargoes offered by Saudi Aramco haven’t found buyers, says David Kirsch, an oil-market analyst at consultancy PFC Energy.
European consumers are paying for the brunt of this supply disruption. Their fuel standards are the highest in the world, meaning their refineries are the pickiest. But the strength of light sweet Brent is dragging up the rest of the crude complex with it, exporting the woe of European fuel consumers to the rest of the world.
Arbitrage window open
The arbitrage window is now open for European products imports from the US and Asia. The only way it will close is if fuel prices in Europe fall – unlikely unless the European Commission relaxes temporarily its fuel-standard requirements, as the US did after Hurricane Katrina in 2005 – or if fuel prices rise in other markets.
In turn, this is creating other anomalies. In the US, supplies are ample. Inventories at Cushing, Oklahoma are full. Crude stocks surged again in the week ending 6 May to more than 370 million barrels, the US’ Department of Energy said last week. And the differential between prices for burgeoning supplies of Canadian heavy oil, now the largest single source of foreign oil in the US market, and WTI are well into double digits. This could widen further if Brent jumps again, dragging WTI up with it. Indeed, WTI looks increasingly irrelevant as a global benchmark.
Meanwhile, a retreat from all commodities – a move seen in spades during the rout earlier this month, which shattered the silver market and others – could also speed up in the coming weeks, making Opec’s decision even more difficult.
The end of the Federal Reserve’s second quantitative easing programme on 30 June will, predict some analysts, drain commodities markets of cash. The big spending spree by hedge funds and other investors that has sustained crude prices is about to end.
The end of quantitative easing will strengthen the dollar. So will weakness in the euro, which is stuttering amid fears of a Greek default. For oil markets, a strong dollar means one thing: weaker crude futures.
Setting free the bears
So Opec has plenty to think about. Its own data say the call on its oil is about to soar. Does it ignore that outlook and risk another damaging jump in oil prices, with long-term implications for demand? Or does it open the taps, at exactly the point when other forces – a softening of demand, the end of quantitative easing, a rise in the dollar – threaten to unleash the market’s bears?