Oil prices followed the equity markets down last week as Wall Street had its worst week ever. Starting above $90 a barrel, oil closed on Friday below $78. In between, there was considerable volatility with oil moving up and down as much as $5-8 a day. The overriding market sentiment that the world economy has entered a lengthy period of contraction remains the key factor in driving oil lower.
Three months of falling demand has led the IEA and the EIA to cut back sharply on their expectations for growth in oil consumption during 2008 and 2009. Despite all the pessimism, however, both organizations are still talking of actual growth in consumption next year with the IEA forecasting a 700,000 b/d increase.
US gasoline prices now average about $3.25 a gallon, down 85 cents in the last 3 months. The rapid price drops have led many commentators to talk about silver linings and oil prices returning to their “proper level” of $40-60 a barrel. While the downward momentum of the equity markets may be enough to send oil down to these levels briefly, it is unlikely to stay there long. Sharply lower gasoline and other oil product prices could slow or even reverse today’s falling consumption. Hurricane-caused gasoline shortages in the southeastern US will be over soon and many third-world consumers who have been suffering from reduced electricity production and lack of other essential services because of high oil prices will likely be back in the market – at least temporarily.
Equity markets and oil prices have been moving so rapidly in recent weeks that there has been no time for the financial and oil industries to react. While the numerous efforts underway to free up the liquidity freeze may ultimately be successful, the effects of these programs could be many weeks or months away.
With oil prices now around $80 a barrel, the average price OPEC receives for its oil is now around $78 a barrel. This is well below what most members need to support their government budgets. There are already some indications that the Saudi’s and their allies in OPEC are cutting back on production as agreed at their last meeting.
Last week’s events were replete with a stream of interviews given by OPEC oil ministers commenting on the precipitous drop in oil prices. As expected, the price hawks, Libya, Iran, and Venezuela, called for production cuts, presumably by other members, that would drive up prices and their revenues. Also as expected, the swing producer Saudis kept their own counsel.
The only certainty is that an emergency OPEC meeting has been called for November 18th in Vienna. Given the speed with which oil prices have been falling in recent days, one would have thought an earlier meeting would have been appropriate, but the US presidential election must take place first. The Saudis are particularly sensitive to this issue.
Opinion is all over the map as to what OPEC should and will do. Most OPEC members seem to favor a production cut to increase prices and maximize revenue. But these are different times and price increases in the face of a serious global recession could just force down consumption and revenues even more. The Saudis and their Gulf allies, who are not quite as desperate for revenues as are some of the other OPEC states, are likely to be more attuned to global economic developments. Some are already talking of OPEC being torn apart if the Saudis don’t go along with a reduction; but as Riyadh holds the trump cards, it is difficult to see what the others could do other than sell all they can no matter what the price.
The OPEC meeting is still five weeks away and, given the pace at which events are moving, that could turn out to be an eternity.
For the first time in decades, a country, Iraq, is putting up nearly 100 billion barrels in reportedly proven, geologically easy to recover oil up for bid by international oil companies. In the first round, six oil fields totaling 43 billion barrels will be licensed, followed by another 12+ fields totaling 51 billion barrels.
The project is already controversial. An oil law has yet to pass the Iraqi parliament. Kurdistan and Baghdad are already at each other’s throats over the contracts the Kurds have let. The status of the oil rich region around Kirkuk has not been settled.
Former Iraqi oil minister Chalabi has already denounced the proposed leases as projects Iraq could develop by itself without the need to share revenue with foreigners. The overriding question remains the security situation.
Oil infrastructure is notoriously easy to disrupt. In Nigeria foreign oil technicians are rapidly being driven from the delta by a relatively small band of militants. Last week the draft of a US National Intelligence Estimate surfaced in Washington pointing out that ethnic and sectarian tensions in Iraq are unresolved and that a new wave of violence could easily erupt.
All this notwithstanding, Iraqi Oil Minister al-Shahristani will host a meeting in London today where prequalified bidders will be given the geological data and financial parameters for the first round of bidding.
The rapid fall in oil consumption and the drop in oil prices coupled with tighter availability of credit is already taking a toll on the oil industry. In trouble are a host of smaller firms that depend on bank loans and stock issues for their working capital. While some of these may be bought up by larger, better-financed companies, many projects are likely to be shelved.
Among the hardest hit will be the Alberta tar sands processing projects which require massive amounts of capital for every barrel of production capacity. With oil now down in the $70s, many projects are no longer viable and are likely to be shelved until conditions are more favorable.
Refinery expansion projects are also being cancelled or delayed. These range from a small expansion in Montana that was canceled last week to a two year delay in a multi-billion Saudi expansion project.
In the US, the buildup of inventories and the rapid drop in natural gas prices is resulting in severe cutbacks in drilling plans.
Several companies have already announced that the cost to drill and produce a marginal barrel of oil is now above world market prices. This is particularly true for deepwater projects.
The well-financed national and international oil companies are likely to complete projects that have already absorbed substantial investment. For the rest, postponements are likely until oil prices and demand stabilize.
--IEA monthly report