Economic Brief

Oil Market and
Budget Developments
Rising optimism helps sustain crude price rally... Kuwait budget surplus could reach KD 6 bn in FY2009/10…
In its latest economic brief on the oil market and budget developments, NBK reports that, crude oil prices were broadly stable through August, the price of Kuwait Export Crude (KEC) fluctuating within the relatively narrow range of $68 and $72 per barrel (pb). In part, this stability reflects a lack of sharp movements in other assets markets, notably the US dollar, which traded to the Euro within the EUR 1 = USD 1.40-1.45 band throughout the month – one of its most stable periods this year.
Although it is perceived that oil may now be trading at ‘comfortable’ levels, it remains to be seen what will happen when the often-quiet summer season ends. The rally in crude oil prices since March has been linked to an improved outlook for the global economy, but there remain doubts about the latter’s strength and durability, as well as the appropriateness of the policy response. A reappraisal of either factor could readily see crude prices break out of their trading range by the autumn. Finally, late summer is traditionally a peak period in the Atlantic hurricane season. Although somewhat unpredictable, hurricane activity has been muted so far, raising the probability of fewer weather-related supply outages than usual this year.
The prices of other major global benchmark crude prices remained similarly stable through August, hovering at or close to the $70 pb mark. While the overall picture for crude prices has been broadly steady, there appear to be dislocations in specific markets. The spread of US-based West Texas Intermediate (WTI) over Europe-based Brent crude, for example, was negative through late July and most of August (against the typical premium paid for WTI). This is related to a counter-seasonal rise in US crude inventories at the Cushing storage facility in recent weeks, driven partly by relatively low refinery runs and rising crude imports.
NBK noted that the more upbeat economic mood has seen some analysts revise up their forecasts for growth in global oil demand this year, albeit by small amounts. The International Energy Agency (IEA), for example, now says that oil demand will fall by 2.4 million barrels per day (mbpd) this year (2.7%), less than the -2.5 mbpd seen in August and the -2.6 mbpd forecast in May. But it has long been one of the more pessimistic forecasters in the market. The Centre for Global Energy Studies (CGES) actually nudged down its forecast to -1.7 mbpd from -1.6 mbpd in July. But increasingly, such revisions are a reflection of new outturn data rather than changes in views about market fundamentals. Most analysts expect oil demand to bounce back by at least 0.5 mbpd in 2010 (the IEA by a much stronger 1.3 mbpd) as the world economy recovers. But note that this would still leave total demand some 1.5% below 2007 levels.
On the supply side, the latest figures published by OPEC show that crude production by the OPEC-11 (i.e. excluding Iraq) rose for the fourth successive month in July, by 58,000 bpd to 26.03 mpbd. Output is now up some 455,000 bpd (1.8%) from its low in March. In addition, Iraqi production showed another strong monthly rise – by 55,000 bpd – and reached a post-war high of 2.49 mbpd. With most OPEC countries registering some degree of production increase – even lynchpin Saudi Arabia – it seems likely that prices are now at ‘comfort’ levels for the cartel’s members and that they are using the situation to recoup some of the ‘lost’ revenues from earlier this year, when prices were at multi-year lows. The increases have reduced compliance with OPEC’s stated target of reducing output by 4.2 mbpd from September levels to 68% from 79% in March. But at the same time, this gap leaves the organization with plenty of room to tighten policy ‘unofficially’ should prices begin to fall again over the next few months.
NBK added that as the world economy appears to be reaching something of an inflexion point, demand side factors are likely to have a major bearing on the path of oil prices over the next few quarters, irrespective of what happens to supply. One component of this will be policy in China, whose purchases of crude (and other resource) stocks in 2Q09 are thought to have contributed to the climb in prices from their March lows. With the recent price recovery and with doubts surfacing about the sustainability of China’s recent growth spurt, Chinese activity could offer less support to crude prices through the rest of 2009. Nevertheless, there is scope for stronger activity in the rest of the world to cushion the blow. Assuming that the CGES’s view that the world economy enjoys a reasonably broad-based, if unspectacular, recovery going forward is correct, oil demand is likely to rise in both 3Q and 4Q09. This should provide support for oil prices, but OPEC would be expected to increase production more or less in line with demand, lifting output by 200,000 bpd in 4Q09 and thereby capping the price of KEC at around the $67 pb mark. An easing-off in the pace of recovery would cause the price of KEC to slip back in 4Q09, leaving an average price of $64 for FY2009/10 as a whole.
A much weaker global recovery – perhaps seeing oil demand average 1 mbpd less in 2H09 than assumed above - would see prices fall back in 4Q09, perhaps to below the $50 pb mark. The fall in prices would stimulate demand into 2010, but unless OPEC instigated deeper production cuts, this would do little to generate a bounce in prices. The price of KEC falls to around $40 pb in 1Q10 and averages $53 in FY2009/10.
If the recent spate of more positive economic indicators bears fruit, however, the global economic recovery could be slightly stronger than expected. In large part, this would tighten oil markets in 2010, but there would probably be some short-term boost to prices, too, especially if OPEC were able to maintain its quota discipline. Under this scenario, the price of KEC rises from $59 in 2Q09 to $77 in 1Q10 and averages $69 in FY2009/10.
Halfway in to the financial year, the prospects for the Kuwaiti government’s budget balance this year are looking increasingly secure. Although we have no official revenue numbers to go by as yet, the price of KEC has averaged $62.3 pb so far, well above the budget assumption of $35 – made at a time when pessimism over the world economy was more or less at its peak. Given the price assumptions made above and if, as expected, public expenditures come in at 5-10% below budget, we estimate that the government will end-up with a budget surplus of between KD 1.1 and 6.2 billion, before allocations of 10% of revenues to the Reserve Fund for Future Generations (RFFG). This compares with the government’s own projection of a KD 4.0 billion deficit for the year and an actual surplus of KD 2.7 billion in FY2008/09.