Oil
market jitters
By Energy Correspondent
Trinidad Express
Port
Spain
Petroleumworldtt.com
02 11 07
Crude oil prices have slipped by 32 per cent from
a peak of US$75.53 in August 2006, prompting widespread
speculation about its future direction. For most
of January, prices hovered just above US$50.00/bbl,
about 12 per cent lower than in December 2006. Falling
prices in the winter months is an abnormal situation
and may be symptomatic of an underlying weakness
in the market. Indeed, prices shot up again last
week in response to cold weather in the United States
coupled with OPEC's planned production cuts, which
came into effect on February 1st. Notwithstanding
the latest upswing, there is evidence in the market
to suggest that prices will soften beyond the current
winter heating season. If these projections hold
to the end of the year, Government may well be facing
a fiscal deficit for the first time since 1998.
OPEC was perhaps the first to foreshadow
the impending market downturn. In October 2006,
OPEC ministers agreed to slash 1.2 million barrels
per day from oil production in an effort to stem
the price slippage. This move brought some semblance
of stability back to the market. Inventory levels
in major consuming nations were reduced and prices
stabilised for a while at about US$60.00 per bbl.
At its December meeting the cartel, which produces
about 1/3 of the world's oil, agreed to postpone
further production cuts to February 1st, when production
was scheduled to be trimmed by a further 500,000
bbls /day, despite the winter demand. In addition
Saudi Arabia, the most powerful of the OPEC members
already is talking about being satisfied with oil
at US$50.00 per barrel. Historically, Saudi Arabia
has led the conservative element within OPEC. Being
the holder of the world's largest crude oil reserve
base, the Saudis are always conscious of the fact
that sustained high prices could stimulate the search
for alternatives, which would be detrimental to
Saudi's future. They may well have decided that
US$50.00 is the new benchmark to keep the world
honest.
The underlying market conditions
suggest that there will be adequate supplies in
the market to keep prices at a lower equilibrium.
According to the US Energy Information Administration
(EIA), global demand is expected to rise by 1.5
million bbls/day in 2007, an increase of 0.7 million
barrels above 2006 growth. China and the United
States are expected to contribute most to the increase
in demand. However, Non-OPEC supply is expected
to grow by 1.1 million barrels per day sharply higher
than in 2006. Non-OPEC supply growth does not deviate
much from the demand projection suggesting that
the call on OPEC will be less than last year. The
EIA projects OPEC spare capacity at over two million
barrels per day, its highest level since 2002. Under
this scenario, it is imperative that OPEC members
strictly observe their quotas. The evidence of the
1980's suggests that this is easier said than done.
At that time, widespread cheating among members
with different fiscal commitments, precipitated
the price crash.
The developments on the market ought
to provide an early warning that Government's fiscal
position could be undermined in 2007. The 2006-7
budget was based on an oil price of US$45.00 per
barrel, and a nominal gas net back price of US$3.50/mmbtu.
Prime Minister Patrick Manning was confident, at
that time, that prices would hold above US$60.00/bbl
for the next two to three years. On this premise,
Mr Manning expects "substantial transfers to
the Heritage and Stabilisation Fund". Five
months into the fiscal year, Mr Manning seems to
be on target. For the period October to January
2007, benchmark West Texas Intermediate crude averaged
US$58.85 /bbl. While the price of gas also has dipped,
it remains well above the expected US$3.50/mmbtu.
Government may be lured into believing
that revenue from gas would supplement the loss
from oil. This assumption could be very misleading.
Over the last three years, oil and gas prices have
exhibited unprecedented correlation (85%) primarily
because of two factors. The first is that gas sales
contract in Europe and the Far East are tied to
the price of a basket of goods including crude oil
and petroleum products. Secondly, the growth of
LNG spot trade particularly to the United States,
a market characterised by inter-fuel competition,
particularly for power generation. Spot cargoes
tend to reflect the overall energy market condition
which is driven in the main by the prices of petroleum
products.
The fiscal position of the Government
is therefore under threat. In the event that prices
fall much lower, the Heritage and Stabilisation
Fund could be the first victim. The "substantial
transfers' forecast by the Prime Minster could quickly
turn to zero after the first quarter. According
to the draft rules of governance for the funds,
Government is under no obligation to put any money
into the fund unless prices are more than 10 per
cent above budgeted. They also may not withdraw
from the Fund unless prices are more than 10 per
cent below the budget price. The worse case scenario
for 2007 is that, outside of the first quarter,
the HSF may not receive any further injections this
fiscal year. But it would be a tragedy if no funds
are allocated for the Heritage purposes.
The second implication is that lower
oil prices could result in a narrowing of the gap
between projected revenue and expenditure. Over
the last six years, Government expenditure has kept
pace with revenues. The problem that arises is that
while revenues will fall sharply and unexpectedly,
expenditure tends to be sticky downwards. Moreover,
workers would continue to make demands for better
pay on the basis of historical rather than forecast
events. The situation is reminiscent of 1983 when
Prime Minister George Chamber's Government gave
public servants a whopping 30 per cent salary increase,
despite clear signs of an economic downturn. Public
servants currently are negotiating salary increases
and it would be interesting to see what the outcome
would be.
Feedback: energyczartt@yahoo.com
Trinidad
Express
Wednesday, February 7th 2007
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