Volume 8, Number 23 Oil Market and Budget Developments

Volume 8, Number 23  Oil Market and Budget Developments
  Saudis attempt to calm market but fundamentals keep oil prices elevated… Kuwait's budget surplus could soar further with the price of KEC remaining above $100   
In its latest economic brief on the oil market and budget developments, NBK reports that fundamental tightness in crude oil markets prevailed over a recent promise by Saudi Arabia to boost its oil output, pushing world benchmark crudes to new record levels in June. The price of Kuwait export crude (KEC) registered a new high of $126.47 on the 25th of June, two days following Saudi Arabia's announcement, to average $122.54 per barrel for the month to that date.  This represents a 6.4% increase over May’s average price of $115.2 and an almost doubling in price averaged during June of last year. 
Saudi Arabia had called for the Jeddah summit of the world’s producing and consuming nations after the WTI benchmark crude tested $140 a barrel. The rapid ascent in prices has resulted in mounting political and economic tensions among the oil importing nations, and the potential for regulatory intervention in several of these countries.  There, the Saudis reaffirmed their promise to boost oil output by 200,000 barrels a day (b/d) effective July 1st on top of the 300,000 b/d increase earlier in the month. Saudi Arabia's initiative came despite recent downward revisions in demand forecasts, the latest and steepest of which by the International Energy Agency (IEA). The Saudis also promised an aggressive program to increase its production capacity to as much as 15 million barrels a day (MBD) by 2018 from its estimated 11.4 million today. 
The IEA has revised its forecast for the increase in world oil demand in 2008 for four consecutive months. The steepest was in May by a hefty 0.3 mbd followed by a smaller 80,000 b/d reduction in June. The revision that puts demand growth at 0.9% (0.8mbd) is attributed to weaker economic growth (particularly in the OECD that is forecast to see a drop of 0.45 mbd), and demand rationing as a result of high prices. The agency also notes, however, that non-OECD demand growth is likely to remain robust at 1.25 mbd, affected perhaps by pre-Olympics Chinese stockpiling, strong demand from the power sector and the continued use of subsidies in countries behind most of the growth in demand last year.
NBK says that OPEC estimates demand growth at a slightly higher 1.1 mbd. Others, however, including the Centre for Global Energy Studies (CGES), expect growth in oil demand to be softer, at 0.6 mbd (0.7%), emphasizing the downside risks to demand from weak economic growth in the OECD. However, we suspect that the recent removal of some price subsidies in Asia (China last week increased diesel and gasoline prices by 18%), may lead to further downward revisions in demand growth. 
BP’s Statistical Review of World Energy 2008 provides an excellent overview of production and consumption trends of energy across regions.  BP estimates that global oil consumption rose 1.1% in 2007, equivalent to an average increase of 1mbd.  Oil consumption in China and India alone accounted for roughly half of the growth in 2007, while the oil-exporting countries of the Middle East and Brazil accounted for another 44%. Consumption in the OECD, however, fell by 0.9% or by 0.4 mbd last year. 
NBK notes that keeping markets tight last year was a drop in global oil production of 0.2%, or 130,000 b/d, the first decline since 2002 according to the BP report.   OPEC production fell by 0.35 mbd “due to the cumulative impact of production cuts implemented in November 2006 and February 2007.”  Non-OPEC production remained plagued by problems, dipping by 0.26 mbd in 2007 according to BP.  The BP report estimated Kuwait's average oil production at 2.62 mbd in 2007, down 2.1% from the previous year.  
Supply has continued to disappoint in 2008. The promised increase in Saudi crude comes at a time output is falling among some large producers.  Nigeria continues struggling with militant attacks against its oil facilities and recently announced that its production is down nearly one million barrels a day from its normal output.  Oil exports from Mexico, Britain and Norway - all major players on the energy market – are also falling.  Russian oil output has been falling since late last year.  As a consequence, global oil inventories have taken a hit, dropping 0.44 mbpd in the first quarter of the year at a time when the market was anticipating some stock building. Inventories dropped further this quarter, making it the sixth consecutive quarter to see a decline.
Fundamentals aside, increasing attention and blame for the continued rise in oil prices this year has centered on the role of speculators trading in energy futures. A recent US Congressional study concluded that 70% of trading in certain key oil futures contracts is now speculative and Congress is now seriously considering placing strict limits on trading in energy futures by investment banks, pension funds and other financial investors. While the evidence suggests that speculation in energy markets has clearly increased, its impact on price remains unclear.
NBK says that the fact remains that the fundamentals of supply and demand continue to produce price pressures. While demand growth forecasts presented above vary, disagreement is even greater when it comes to non-OPEC supply. If we take the more pessimistic forecast for global oil demand growth by the CGES of 0.6 mbd in 2008 and assume a 0.7 mbd increase in OPEC output in 3Q08, we should expect stock cover to remain unchanged and prices to stay near their current levels in summer. A rebound in stock cover would be unlikely before 1Q09 as the CGES's anticipated increase in non-OPEC supply of 0.7 mbd in 4Q08, mostly as a result of higher production in the Former Soviet Union, would barely cover the seasonal rise in demand for heating fuel. Such a scenario would produce a KEC average of $121 in the second half of the year and $118 for FY08/09.
However, non-OPEC output could still disappoint, as any forecasts of significant growth in non-OPEC supply are wrought with uncertainties. Declines in the North Sea and Mexico’s giant Cantarell field, for example, could be even steeper than forecast and not offset by increases from smaller fields elsewhere. Should this coincide with stronger demand growth as the IEA and OPEC expect, crude prices could spiral higher, pushing KEC to new highs. However, as long as stock cover does not deteriorate due to additional supplies from Saudi Arabia, KEC would still average $125 and $128 in 3Q08 and 4Q08, and $125.8 for FY08/09 as a whole.
On the other side, NBK notes that the main downside risk to crude prices stems from even weaker than expected growth in global oil demand if the global economy tips into recession, coupled with a strong increase in non-OPEC supply as predicted by OPEC. In that case, KEC is likely to fall back below $100 by 4Q08, but still average $100.7 in FY08/09.
Since Kuwait’s budget for FY08/09 is predicated using an assumed oil price of $50 per barrel for KEC, even this latter scenario prices would not be disastrous as far as the government’s financial position is concerned.  Under the three scenarios, KEC averages between $101-126 in FY08/09, an increase of 34-68% on the $75 recorded the previous year. If government spending comes in on budget at KD 18.97 billion, an increase of 69% over the previous year's budget, the FY08/09 surplus would still come in at between KD 6.4-13.8 billion before payments to the Reserve Fund for Future Generations (RFFG). If, as usual, government spending comes in 5-10% below budget (except for the KD 5 billion exceptional transfer to cover potential future liabilities in the social security fund), the FY08/09 surplus would come in at between KD 7-15 billion before payments to the RFFG. The high-end scenario in this range of possible outcomes would deliver a surplus significanlty larger than the record KD 8.5 billion we expect to have been registered in FY07/08 that closed in March.