KEY FACTORS IN THE SHORT AND LONG-TERM OIL MARKET OUTLOOK

Oil prices have been high for more than four years. From 2000 through 2002 OPEC supply restraint was an important factor that contributed to the rise in oil prices to the upper $20s to low $30s range. In early 2003 the oil workers’ strike in Venezuela, concern about the US invasion of Iraq, and supply disruptions in Nigeria led to the highest quarterly average price in 20 years. Crude oil prices in January and February this year were near the high levels seen a year ago. With no equivalent supply-side elements in today’s market, why are prices so high, and how long will they remain so?

• Tight global oil demand and supply balance. In CERA’s view, after accounting for additions to the US Strategic Petroleum Reserve, first quarter world oil supply is evenly matched with demand. Indeed, demand may have surged ahead of supply early this year. Consequently, there has been little rebuilding of inventories from the generally low levels at which they began the year. This is the case even though OPEC 10 output was 1.5 to 1.7 million barrels per day (mbd) above quota in December and January.
  
• Low US crude oil and gasoline stocks. A particular source of price support within the global inventory picture is in the visible and influential US market, where commercial crude oil inventories in general have remained at very low levels since the strike in Venezuela contributed to a steep decline in stock levels. In late February stocks were 29 million barrels below the 1998–2003 average for that time of year. In addition, low US gasoline stocks combined with concern about potential logistical glitches—linked to changes in specifications this year—are among the pillars of the current strength in crude prices.
  
• OPEC’s implicit defense of higher oil prices. Although since December Saudi Arabia has moderated its support for prices above $28 per barrel for the OPEC Basket, the outcome of the February 10 OPEC meeting in Algiers indicates ongoing support within OPEC for implicit price targets that are, at a minimum, in the upper half of the $22 to $28 target range for the OPEC Basket (approximately $24–$32 in terms of WTI.
  Also, in Saudi Arabia’s view, if oil inventory levels remain low, it should not be a concern since OPEC is the de facto inventory cushion. A desire to keep inventories at low levels is consistent with an implicit policy to aim for prices at or above he high end of the target range.
  In addition, continued weakness in the dollar-euro exchange corresponds with ongoing support within OPEC for defense of higher oil prices. For the rest of 2004 these factors are expected to remain supportive of a strong oil price environment. In addition, relatively slow gains in Iraqi output and the potential for export bottlenecks in Russia could also contribute to price strength. But beyond 2004, will prices remain high or are weaker prices in store?

KEY FACTORS INFLUENCING OIL PRICES TO 2010

A wide range of factors influences world oil demand, supply, and price. Unexpected developments can and will occur that lead to sudden changes in theoil market environment. For example, the rapid depreciation of Thailand’s currency in mid-1997 was the spark that led to the East Asian financial crisis of 1997 and 1998.
This crisis weakened oil demand in what had been a very important region for growth in global oil demand and, combined with rising OPEC oil production, helped to precipitate the 1998 oil price collapse. The lesson of the 1997 currency crisis in Thailand is that market volatility is often catalyzed by surprise events. The oil market environment to 2010 will be affected by unexpected developments that have a significant effect on oil prices. However, there are also a number of factors that undoubtedly will have an effect on price. These are: China’s economic growth, Russian oil production, uncertainty in the Middle East, OPEC cohesion, and the role of the United States in the world. Although it is clear that these elements will be influential in determining the oil price environment, the uncertainty is whether they will push prices down or up. In any case, they merit close attention.

• China’s economic growth. China’s has become increasingly important in fueling expansion of global oil demand. In 2003 China accounted for nearly one-third of total world oil demand growth. Long-term prospects for strong growth in China’s economy are impressive. Continuing strong Chinese demand growth would support prices, but if China’s economy hits a rough patch for a year or more, it would weaken oil prices.
  
• Russian oil roduction. The “miracle in the oil fields” of Russia in recent years has had a significant impact on global supply. Since 1999 Russian oil output has increased by 2.6 mbd—a 43 percent gain. But Russia faces the possibility of slower growth if export infrastructure does not keep pace with rising oil output. Without growth in Russian oil supply, it is a very different oil market environment.
  
• Uncertainty in the Middle East. The lack of clarity concerning the future course of Iraqi production combined with political and social uncertainty in key Middle East oil producers are factors that point toward a potentially volatile decade in the world’s most important oil producing region.
  
• OPEC cohesion. OPEC faces serious challenges in coming years: non OPEC production is expected to record significant gains; Iraq may be reintegrated into the quota system, and a number of OPEC countries are making large additions to oil production capacity. These elements are potential sources of friction within OPEC that could challenge its cohesiveness.
  
• Role of the United States in the world. The pace of economic growth in the world’s largest oil consumer will, of course, be critical to the oil price environment. Also, the degree to which the US exerts its political and security influence around the world, especially in the Middle East, will help to shape the global geopolitical and economic climate. To be sure, these five factors do not represent a comprehensive list of important elements in the oil market. Developments in Latin America, West Africa, the Caspian region, and South Asia will also prove to be important. What’s certain is that the oil market will be in for a bumpy ride over the next decade.