Unstable Conditions Put Oil Markets in a Vise
June 11, 2004 2125 GMT
Summary
Though the "terror premium" is partially at fault for high crude oil
prices, rapidly growing demand is quickly absorbing slack in the
system. This sets the stage for more volatile price surges, with very
little room to maneuver around shocks or singular disruptions
emanating from unstable producing countries such as Nigeria, Iraq,
Saudi Arabia and Venezuela.
Analysis
Energy prices are high because of the "terror premium," placed at
approximately $8 per barrel by sources affiliated with trading houses
and major oil firms. This premium is expected to rise and fall along
with global perceptions of the terrorism threat, contributing to the
volatility of oil prices.
In the immediate aftermath of the May 29 attack against an expatriate
compound in Khobar, Saudi Arabia, oil prices shot past $42 per barrel
-- but since have dropped as low as $35 per barrel. More attacks in
Saudi Arabia are imminent, so this unstable pricing pattern will
likely continue.
Terrorism threats alone do not explain the volatility in pricing,
which has hit record highs (when not adjusted for inflation). The
explanation lies in tight supplies, high demand or -- in the case of
the current situation -- both.
Maxed-Out Supply, Greater Demand
After the OPEC meeting in Lebanon on June 3, the cartel officially
raised its combined production by 2 million barrels per day (bpd) to a
combined total of 25.5 million bpd. The OPEC quota system is
pointless, since all members -- with the exception of Saudi Arabia and
the United Arab Emirates -- produce as much as they can to capitalize
on high prices.
Global supply is effectively maxed out. No non-OPEC state regularly
keeps spare capacity on hand, and only the UAE and Saudi Arabia have
had any surplus for the past several months. Even those nations are
committed to full production. Any additional supplies that might
trickle onto the market would come from "surge" production, which is
sustainable only for short periods.
The real story is on the demand side. The years 2003 and 2004 are the
first in nearly a generation in which the United States, Europe and
Japan have enjoyed strong simultaneous economic growth. China -- a
new, somewhat shaky force in the global economy -- continues to grow,
taking its place in 2003 as the world's second-largest oil consumer.
As a result, the International Energy Agency on June 10 reported a
significant upward revision in global demand. With demand for oil
stronger than expected in Brazil, China, India and the United States,
global demand by year's end is projected to increase 2.3 million bpd
and hit a new record high of 81.1 million bpd.
The combination of a terror premium, tight supply and strong demand
leaves little margin for error. Any large disruption to the supply
chain -- normally offset with fresh production from Saudi Arabia --
could significantly impact the oil markets.
However, there is no shortage of places that could experience a sudden
disruption.
Suppliers at Risk
Nigeria remains on a political knife-edge. On June 11, a nationwide
strike called by the Nigerian Labor Congress over the price of fuel
was suspended after its third day. The contentious issue of domestic
fuel prices continues to hound Nigerian President Olusegun Obasanjo,
who must withdraw government subsidies to reduce the budget burden,
curb smuggling of refined products and attract investment to the
country's shoddy refineries.
Though Nigeria's oil export system can handle low levels of
instability, sustained surges in labor actions, civil unrest and
tribal violence could force a halt to exports. Such an event occurred
in March and April 2003, when ChevronTexaco and other companies had to
declare force majeure when they were unable to meet contractual
obligations for crude exports.
Iraq is similarly vulnerable to disruption. Though the Iraqis formally
took back the reins of their oil industry June 8, the security
situation is still not amenable to large production increases.
Stratfor stands by its assessment that Iraq will ultimately prove to
be the world's next Saudi Arabia in terms of oil production. Before
that can happen, security must be re-established on the ground.
Sabotage remains a problem in Iraq. Since June 2003, Baathist
guerrillas have been attacking the northern export route that flows
from Kirkuk to the Turkish Mediterranean. Such attacks expanded
exponentially in the spring of 2004, when foreign jihadists began
copying Baathist tactics. Before that time, jihadist attacks were
limited mainly to personnel; now they also are targeting
infrastructure, with recent attacks against a major pipeline that
provides oil to a domestic power plant. Loading platforms off Iraq's
Persian Gulf coast also have been damaged by suicide attack boats.
Likewise, a main oil export pipeline was damaged at the Al Faw
Peninsula crossing south of Basra.
Since Iraqi production will likely remain haphazard in the near
future, there is little reason to expect it to rise appreciably from
the post-2003 war high of 2 million bpd during the next few months.
Instability also grips Saudi Arabia, with al Qaeda militants
continuing to target Western expatriates who work in the Saudi oil
industry. As advanced technical workers leave the kingdom, Saudi
Arabia's production capacity will slowly deteriorate. Loss of key
personnel also could make it more difficult for Saudi Arabia to tap
into its much-touted spare production capacity.
Such a development would not affect current output. Militants
affiliated or inspired by al Qaeda could start taking swipes at Saudi
oil assets. Though such copycat groups are not as likely to succeed as
al Qaeda militants, an attack against a critical installation -- such
as the Ras Tanura loading platform in the Persian Gulf -- could pull
hundreds of thousands of barrels off the market.
Finally, Venezuela faces an acute crisis that will affect its oil
sector. President Hugo Chavez has not proven to be a friend of the
energy markets. His efforts to politically insulate himself by purging
PDVSA of its technical core have set the once-mighty state oil firm on
the way to becoming a third-rate company.
Barring electoral irregularities, Chavez is expected to lose an Aug.
15 recall referendum. If the past is any indicator, the president will
not go quietly. Chavez used street riots to fight back the last time
he was deposed, and before becoming president he attempted a coup.
Stratfor sources within the country indicate that the Chavez
government has armed a large number of fervent supporters, so there is
little reason to expect stability, should voters recall the president.
Chavez likely will attempt to postpone the referendum, which
constitutionally must take place before Aug. 19. Without the
referendum, Chavez or Vice President Jose Vicente Rangel will serve
out the remaining two-year term.
Such an outcome could send the opposition into the streets. Even if
the crisis dies quietly, Venezuela's government would be left in the
hands of Chavez loyalists who already have damaged the country's oil
sector. The only outcome that might help reverse the sector's decline
-- the peaceful, near-term replacement of Chavez -- is also the least
likely to occur.
One or more of these major oil suppliers -- Nigeria, Iraq, Saudi
Arabia or Venezuela -- could face a critical situation in the near
future that would disrupt production. Considering the new outlook for
demand -- and the lag time needed for high prices to generate new
sources of global supplies -- the impact of near- to mid-term shocks
to the oil markets would be greatly amplified, with little available
relief.
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