Energy's Price Dilemma: Politics vs Fundamentals

By Hanley, John | Futures (Cedar Falls, IA), February 1991 | Go to article overview

Energy's Price Dilemma: Politics vs Fundamentals


Hanley, John, Futures (Cedar Falls, IA)


Energy's price dilemma: Politics vs. fundamentals

Energy markets are still balancing uncertainties in the Middle East and the Soviet Union with concerns there is too much oil as the seasonally weak second quarter nears.

Trading activity since Iraq invaded Kuwait in early August has shown price movements are exaggerated in either direction when the market concentrates on political and military worries on one hand or bearish fundamentals on the other.

Although the Soviet Union is the world's largest producer and the sensitive Persian Gulf region has 45% of the global oil reserves, many compelling factors can erode a so-called "war premium." These include the mild Northern Hemisphere temperatures in early winter and adequate crude oil and distillate fuel supplies, including reports that much oil from the Organization of Petroleum Exporting Countries (OPEC) is floating on tankers in the Mediterranean Sea. Slowing economies and higher prices also have limited demand.

"Altogether, we see a mounting downward pressure on price," says Cyrus Tahmassebi, chief economist and director of market research at Ashland Oil Inc., who looks for $20 per barrel crude oil in the summer if the crisis has been resolved.

The International Energy Agency (IEA) estimates consumption by the industrialized countries of the Organization for Economic Cooperation and Development (OECD) in the first quarter of 1991 will decline 1.5% to 37.9 million barrels per day. The IEA estimates second-quarter consumption will fall 3% to 35.4 million barrels per day. Non-OECD consumption should increase 2.5% in 1991 vs. a 4% increase in 1990.

Increased production from Saudi Arabia and Iran, helping OPEC eliminate the shortfall from the embargo against Iraq and Kuwait, also fueled market expectations for crude oil to fall below $20 per barrel.

A developing problem could be some OPEC members cutting back production to allow Iraq and Kuwait back into the cartel's production equation eventually. Customers may also be hesitant to resume full business relationships considering the volatile political situations.

"If the will is there to turn it down, they can do it quickly," says Jon O'Neill, trader with Deutsche Shell in Hamburg, Germany. "The question is if the will is there."

This trader says supply and demand alone place crude oil near $15, with momentum possibly pushing prices toward $10 initially.

"If peace breaks out, we most likely will see a repeat of 1986 (when crude oil prices plummeted from above $30 per barrel to $10)," O'Neill says.

Attempts to re-enter the market could force Iraq to offer discounted oil prices to world customers, undercutting other producing countries, sources say. This would reflect actions following the United Nations embargo when Iraq attempted to sell oil in mischievous ways.

"Iraq and Kuwait will have problems after the crisis reorganizing themselves, attracting expatriots and recapturing market share," Tahmassebi says. "Customers might be unwilling to come back to Iraq and Kuwait, particularly if other countries that increased production try to keep their market share."

Although nations like Japan have improved energy security due to previous oil shocks, some concerns remain in the U.S. market about falling domestic production while imports account for about half the supply.

U.S. production has been falling at an average rate of nearly 400,000 barrels a day per year. Some sources don't expect the level to rise greatly in coming years, despite any price spike.

According to Al Roark, energy economist at the WEFA Group in Bala Cynwyd, Pa., domestic production reached 9.44 million barrels per day in 1972 and has fallen since to 7.61 million barrels per day in 1989. Output dropped off 470,000 barrels per day from 1988 to 1989.

Adding to concerns about U.S. supplies, despite increased output from Alaska, is the fact much of it comes from stripper well production, which results in a slow daily rate of production, according to Roark. …

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