In its latest economic brief on the oil market and budget developments, National Bank of Kuwait (NBK) reports that OPEC’s recent decision, on January 30, to maintain its output quotas at the level agreed upon during their previous meeting is likely to provide further support to an already bullish oil market. Since OPEC’s December 10 decision to curb output effective January 1, oil prices moved upwards again, aided by unexpected production problems at non-OPEC producers and continued strong demand further exacerbated by cold weather. Brent crude averaged $44.2 in January, jumping $4.6 from its level the previous month.
The price for Kuwait export crude (KEC) also rose, albeit by a smaller amount. During the first three weeks of January, KEC averaged $34.41, some $2.7 above its December average. Spreads between KEC and lighter crudes widened again to $11.7 with WTI and $9.2 with Brent, up from $11.5 and $7.9, respectively, mostly reflecting bottlenecks in transportation and refining.
On the demand side, winter chill in the US has raised heating oil consumption, while continued strong demand by Asian economies –China in particular– caused upward revisions in growth forecasts for 2005. Both the Centre for Global Energy Studies (CGES) and the International Energy Agency (IEA) adjusted their growth forecasts upwards to 1.7% and 1.8%, respectively, after having scaled them back slightly in December. Although such growth is only half of that seen in 2004, the CGES believes demand growth is sufficiently robust to ensure another year of record high oil prices.
On the supply side, the market remains tight with OPEC scaling back production by 1 million barrels per day (mbd), effective January 1, and unexpected disruptions in non-OPEC supplies. From bad weather conditions in the North Sea to slow restoration of production in the Gulf of Mexico to strikes and sabotage acts, such unexpected factors caused a drop in OECD crude stocks, bringing back fears of supply shortages.
A 1.5% drop in OPEC’s output in December ahead of the planned cuts did not help ease market concerns. Reductions came mainly from Iraq and Nigeria, though Saudi Arabia, Kuwait, and Qatar also trimmed their output slightly. At 1.5 mbd, Iraq’s output reached its lowest level since July 2004, due to continuous attacks on oil installations, power shortages, and lack of maintenance. Kuwait’s output during the month stood at 2.4 mbd and should drop further to 2.33 mbd in January. At the same time, Kuwait’s production capacity climbed to 2.8 mbd with the completion of work on a new gathering center.
NBK‘s economic brief mentions that OPEC’s quota decisions in the coming months are likely to be driven by changes in crude inventories. Despite the rebound in oil prices that saw WTI flirt with $50, the organization believes that oil markets are adequately supplied at present, and various members are even weighing the possibility of further output cuts in the second quarter to avoid a stockbuild during a period when demand witnesses a seasonal drop. Analysts interpret this as a signal that OPEC would like to keep its basket price near $40, which is supported by its announcement that it will also temporarily suspend its long defunct price target band of $22-28. OPEC’s basket averaged $40.5 in January and $36 in 2004.
NBK reports that given the current outlook for demand and for non-OPEC incremental supplies, if oil production by OPEC-10 remains steady at around 27.2 mbd and Iraq’s output averages 2 mbd during 2005, oil prices should remain strong through winter, with KEC averaging $33.4 in 1Q05 and $33.1 for the whole year.
Still, demand growth could prove stronger than expected, moving OPEC to increase output back to 29.5-30.0 mbd by Spring, which should keep prices on a mildly rising trend. In such case, KEC could average about $35 in 1Q05 and climb gradually to near $37 by year-end.
The down-side risk to oil prices may come from a weakening demand or higher than expected output from Iraq or non-OPEC producers. The first is highly unlikely, though the second may surprise markets. If OPEC producers fail to maintain discipline in observing agreed upon cuts, oil prices may spiral downwards, with KEC slipping under $30 by Summer and averaging $25 in 4Q05.
Under the current outlook for oil markets, NBK’s price forecast for Kuwait crude for fiscal year 2004/05 is fairly unchanged from last month, with the average price for KEC expected to range between $33.7 and $34.2. Total government revenues would hence come in between KD 8.7 billion and KD 8.9 billion, compared to budget projections of KD 3.3 billion. NBK’s forecast for actual budget expenditures is also unchanged at KD 6.1-6.2 billion, versus a budget projection of KD 6.5 billion. Kuwait could therefore reap a record budget surplus of KD 2.6 billion to KD 2.7 billion.
