Over The Barrel
Introduction
Ever since the formation of OPEC (Organization of Petroleum Exporting Countries) in 1960, the meetings in which crude oil supply, demand and prices are discussed have been a key focus of the oil market. These meetings have brought together both friend and foe in deliberations targeting the maintenance of what members saw as a fair oil price. Discussions have addressed not only key budgetary issues for member governments but also saw that the longer range interests of oil exporters were addressed. At times highly political, they have been largely dominated by the wishes of individual member governments that exerted the most impact by way of their production levels. Saudi Arabia, as one of the founding members, has had the greatest impact due to there ability to marginally increase or decrease production at will, allowing their oil ministers to exert the greatest influence on the deliberations. For a long time, changes in their production determined the ultimate direction of the market.
The meeting scheduled to begin on September 11th might shape up to be one of the more significant meetings in recent memory, given the conflicting signals being presented by world oil consumers and OPEC members. On the one hand, the OECD countries, as represented by the IEA (International Energy Agency) contend that world oil supplies will grow increasingly short as demand overtakes supplies. On the other hand are a variety of OPEC members who contend that world crude oil supplies are ample but refining capacity is short. The Saudis, who are a key contributor to the discussion, have been largely silent with respect to their own ideas in regards to prices and production levels.
Key considerations effecting the eventual outcome and decisions by the Saudis will be:
- Forecasts for economic growth, particularly in non OECD areas and how the fallout from the credit crisis impacts these areas and ultimately energy usage.
- Existing capacity of OPEC's recoverable reserves.
- Prospective impact of high energy prices on longer term demand trends and subsequent substitution of alternative energy sources.
- Growing environmental activism and its impact on energy usage and the adoption of alternatives to petroleum products.
- Refinery capacity restraints and its impact on product availability.
Irrespective of the outcome, world economic growth will continue to support demand at levels that are unsustainable given current OPEC supply restraints and limits on the Saudi's ability to be the swing producer.
OPEC Overview
Source: IEA
In July, OPEC production rose to 30.5 mb/d. Increases in Iraqi and Nigerian production levels accounted for the bulk of the increase. Prospects for the higher level in Iraq to be maintained are far from certain. In Nigeria, the political situation remains volatile; however a recovery in production levels appears possible. In Venezuela, a shortage of skilled managers and overseas investment continues to work against prospective increases in output.
Price Outlook
Notwithstanding a quota increase for the fourth quarter, which appears to be a less than even probability, the world faces a deficit situation in the fourth quarter of 2007 and into the 1st quarter of 2008 approaching an average of 1.5 mb/d. Whether or not OPEC action develops now or later, world crude oil inventories and product stocks are likely to get tighter in the absence of a dramatic tailing-off in demand. Upside price risk will likely be high long term despite the retrenchment in U.S. demand growth as other countries, driven by weakness in the dollar and a growing global economy, continue to expand demand. Although the Dec 07 crude contract might be sensitive to any move by OPEC to increase production given that no quota increase has been priced in, a break in the Dec 2008 contract toward the 69.30 level from 71.00 currently should be seen as another buying opportunity (we are currently long on a trade from August 16th) risking the 67.80 area and upside potential of 78.00-80.00 longer term.
Charts Courtesy of DTN
If you would like more information on Over the Barrel, please contact Steve at 1.877.377.7931 or stephen.platt@archerfinancials.com.
The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.
