OIL

A “Soft Landing” for Oil Prices and OPEC

Feb 23 (Stratfor)

Summary

Crude oil prices hit $30 per barrel this week, the highest in a decade, sparking concern about damage to the global economy. In an upcoming summit, key oil producing nations face a choice. They can continue to keep a lid on production and keep prices high – but run the risk that some producing nations will break ranks to capitalize on record prices. Or producing nations can attempt to manage the price of oil downward in the hope of keeping each of their members in line. A “soft landing” for prices seems likely in the coming months, probably driving the price of oil down by as much as $10 per barrel.

Analysis

Oil prices historically peak during winter, then dip during spring. But this year, oil prices continue to increase even as February comes to an end and temperatures rise. Yet, attitudes are beginning to shift among oil producing nations, and many are beginning to consider increasing production that would, in turn, affect the price. Given the economic danger of high oil prices and the continued difficulty of maintaining a cartel, we expect that the March 27 OPEC summit will result in a moderate production increase. This will lead to a price decrease and encourage future cartels.

Current oil prices are far above their historic level. The price of oil was steady between 1950 and the mid-1970s, ranging between $11-14 a barrel in 1992 dollars, according to the U.S. Energy Information Agency. Prices skyrocketed during the OPEC oil embargo of the late 1970s and never completely returned to previous levels. If we assume that there is a “real” price of oil, it seems safe to say that the current level is too high.

Several months ago, economists worried about the inflationary effects of $25 per barrel of oil. Now the price has surged past that mark, sparking serious concern about the impact on the world economy. High oil prices contribute to high interest rates, which could negate the economic growth of oil-consuming economies. This, alternately, poses a problem for oil producers: Stagnating economies use less oil than healthy ones. This is especially true for Asian economies, which once were major users but now are struggling to recover. The question is what will oil producers do next?

Mexico, Saudi Arabia and Venezuela are the keys to unlocking this puzzle. They organized last spring’s production cuts, of which Saudi Arabia and Venezuela have made the lion’s share. Thus far they have been extremely successful. The price of oil has tripled in little more than a year, and producers are awash in revenues. However, all three are U.S. allies and suppliers to its domestic market. All three have come under pressure to increase production. And all have adjusted their 2000 government budgets to plan for oil prices below $20 per barrel.

Representatives from all three countries have begun to offer soothing public statements about the possibility of increasing production – which would ultimately lower prices. Mexican Energy Minister Luis Tellez said Feb. 15 that output was likely to increase after the current OPEC arrangement expires at the end of March. Venezuela cited concern for the world economy when it said “there is no point in provoking critical situations,” on Feb. 16, according to Agence France-Presse. Iran, the second-largest oil producer after Saudi Arabia, seems to hold similar sentiments. Although it has had trouble complying with the quota regime, it has consistently emphasized the need for stable, sustainable oil prices, which it needs if it wants to reform its economy.

The cartel organizers have enjoyed a natural advantage. The increased winter demand for oil allowed the cartel members to gradually loosen restrictions on oil output without changing prices. Compliance dropped from 91 percent in September to 76 percent in January, according to the International Energy Agency. But it will be difficult to tighten restrictions on production as warmer weather arrives. As prices drop on their own, Venezuela and Saudi Arabia will be faced with a choice: either control and guide a price decrease or wait until enough producers break from the herd to start a stampede.

Rumors have been coming out of Venezuela about a “soft landing,” a controlled production increase that will lower prices somewhat but maintain long-term discipline among producer nations. Theoretically, a production increase dropping the price to, say, $23 per barrel, would still be extremely profitable for oil producing nations, yet would take some economic pressure off consumers like the United States and Japan. A benefit of a “soft landing” is that it maintains a level of confidence between oil producers, confidence that can be used to keep prices stable by coordinating future production cuts should the price go too low.

Several variations of “soft landing” plan have been floated, with production increases ranging from immediate hikes of 1.7 million barrels per day to several phased hikes of 500,000 barrels per day over the summer. Either way the price will drop, in part due to increased confidence among buyers. After a short period of volatility, the price should settle, probably somewhere between $20 and $25 per barrel, which will relieve inflationary pressure. Demand will stay strong as reserve oil stocks are replenished and people take to their cars in the summer. Strong demand will keep revenues flowing to oil producers and encourage the survival of the cartel.

OPEC members Kuwait, Libya and Qatar have taken a hard-line stance on production increases and blamed skyrocketing prices on financial speculators rather than basic supply and demand. But Kuwait’s rhetoric is likely based on domestic politics, as its ruling party is under pressure to keep foreign development out of the oil fields. Libya and Qatar have little credibility as they have consistently oversold their own quotas and profited handsomely from the high prices.

Several OPEC members have already indicated support for a production increase. Indonesia said Feb. 15 that it wanted prices to drop and stabilize at between $22 and $26 per barrel. This is an odd position; Indonesia has one of the lowest compliance rates of OPEC members. The best explanation is that Jakarta is under pressure from other Asian nations to decrease prices in order to stimulate regional economies. In January, the United Arab Emirates said that it would increase production if oil reached $30 per barrel, according to a report by Australasian Business Intelligence.

Many of the potential quota-busting nations, such as Indonesia and Libya, do not have significant amounts of excess capacity at the moment. Each has an excess capacity of only about 200,000 barrels per day. Iraq’s oil is still unavailable due to U.N. sanctions. Baghdad’s normal quota has instead been divided up by other producer nations.

If Iraq can shake off its sanctions, it has the capability to flood the world oil markets. Baghdad, however, has been giving mixed signals. On Feb. 14, it announced oil production cuts of 200,000 – 300,000 barrels per day; the same day the government also requested a 3.4 million barrel per day OPEC quota. In doing so, it was demonstrating that it could make prices rise or drop on its own. Iraq is a wildcard. It could comply with the United Nations tomorrow and be exporting oil a few months later. Or it could battle the United Nations for another year.

Another potential problem is Nigeria, which so far has stuck close to quota. However, most of credit for that goes to the indigenous tribes in the Niger Delta whose unrest has interrupted oil production. With that exception, Nigeria seems tailor-made for quota-busting. According to the Energy Information Agency, Nigeria could produce about 600,000 barrels per day over the current allotment – assuming the oilfields are under government control. President Olusegun Obasanjo’s hold on power is not secure, and he may feel it necessary to take the short-term advantage of grabbing quick oil revenues.

A combination of dangerously high oil prices, the continued temptation to cheat and the desire for price stability make a soft price decrease the most attractive option for OPEC. Mexico, Saudi Arabia and Venezuela have two choices: They can continue with the present course and eventually watch prices free-fall, or they can control the fall, which would lower oil prices by late spring. This provides oil producers with less revenue in the short term, but maintains the credibility of the cartel and its members, thus laying the groundwork for future coordination.

FROM THE EDITORS : On the threshold of the Summit of OPEC countries to be held on March 27, the situation around oil prices is critically tensed. The prices raised up to US$ 30.05 per barrel, fell to 26.67. What will happen further? A free fall or a controlled moderate reduction? Bill Clinton proposed the OPEC to reduce the prices and warned that he was ready to use the strategic reserve, if necessary. The prices are unstable and this causes resentment even by those who now gains an incredible profit from overstated prices. Against this background the Caspian Sea attracts attention. Stratfore analysts point to the possible opposition between Iran and Russia in the Caspian region, as Moscow is eager to regain its influence in the Transcaucasus and Central Asia, after Putin came to the Kremlin. This does not meet the Teheran’s interests, as it prefers to consider the region as a buffer. On the other hand, Georgia wishes to play a key role in transportation of the Caspian oil and despite the prior agreements, it demands a higher price for transit of mineral resources. This does not make the situation more stable. Besides, there is unpredictable Iraq, which may literally flood the world market by its oil. Despite the UN sanctions, Baghdad visually demonstrates that it is still able to make prices raise and fall. At the same time, OPEC countries, despite the initial partial split, seem to be ready to reduce prices to US$ 20 to 25 per barrel. On the whole, this meets almost everyone’s interests.

Georgia Looks For Key Role In Regional Energy

By Michael Lelyveld

After three months of delay on the Baku-Ceyhan pipeline for Caspian Sea oil, the focus has fallen on Georgia’s demands. The country hopes to play a key role both for the Caspian and its neighbors on the Black Sea. RFE/RL correspondent Michael Lelyveld takes a look at the latest developments.

Washington, 21 Febr

(RFE/RL)

Oil industry officials have grown impatient with Georgian demands that have blocked a major Caspian Sea pipeline. But some reports suggest that the sticking points may be minor compared with the project’s overall costs.

Progress on the Baku-Ceyhan oil line between Azerbaijan and Turkey has been stalled for three months due to Georgia’s conditions for the route that crosses its territory.

Although participating nations signed a series of pacts at the Istanbul security summit on November 18, they were unable to complete a host government agreement with Georgia in time. Tbilisi has since pressed a series of demands, prompting a BP Amoco official this week to call the lack of progress “frustrating.”

Officials of Georgia, Turkey, and Azerbaijan have been meeting in Baku over the past week to resolve the key remaining difference over transit fees. Georgia has reportedly sought 20 cents per barrel for the oil that will transit the $2.4 billion line.

BP Amoco said this week that other demands over security, environmental damage and compensation for land have already been settled. Strictly by the numbers, the fee would bring $73 million a year to Georgia, when deliveries reach a peak of 1 million barrels per day. It is a seemingly small sum for a project that may yield more than $100 billion in total revenues for the Azerbaijan International Operating Company, which is developing Caspian offshore fields.

The difference could actually be even smaller. Georgia is already said to be earning 17 cents per barrel for the “early oil” exported through its Black Sea port of Supsa. The three-cent increase for Baku-Ceyhan translates to only $11 million a year, an amount that could soon be dwarfed by the cost of delay.

Negotiations appear to be strained because the partners in Baku-Ceyhan have already negotiated an overall transit fee of $2.58 per barrel, with $1.59 reserved for Turkey. As a result, Georgia’s demand may have the effect of pitting it against Azerbaijan, which might have to take a smaller share.

But the real key to the problem may be Georgia’s plan to build a new refinery at Supsa that could make it a top exporter of fuels to neighboring nations. After months of focus on the interests of Turkey and Azerbaijan, the importance of Georgia is now becoming clearer as an energy gateway between the Caspian and the countries of the Black Sea.

Last week, officials of the Georgian International Oil Corporation said construction of the $300-million refinery at Supsa would only begin after final agreements are reached on Baku-Ceyhan, the Caspian Times reported.

Georgia’s demands are said to include a share of the crude that would flow over the line. The oil would be processed at Supsa and Georgia’s existing refinery at Batumi. Georgia’s ambition may be seen in the plan to eventually raise the capacity of the new refinery to 240,000 barrels per day. Sources for supply include not only Azerbaijan but also Kazakhstan. Potential markets for fuel are northern Turkey, Ukraine, Moldova, Bulgaria, and Romania.

Refining and exports offer Georgia a chance to multiply its transit earnings many times over with higher-value products. In addition, the plan may not necessarily depend on completion of Baku-Ceyhan.

Georgia is already host to the only working pipeline route from the Caspian with its “early oil” line to Supsa. The country also moves oil from Kazakhstan to the Black Sea by rail. Those routes will likely be expanded for far greater volumes from the Caspian if Baku-Ceyhan is not built. Either way, Georgia wins.

Georgia’s commanding position may account for its persistence in negotiating its demands. It may feel heavy pressure from Russia, which wants Baku’s oil to flow to Novorossiysk. But here, Georgia may also gain the upper hand.

Some analysts believe that Russia will need Georgia to complete its plans for delivering more gas to Turkey if its ambitious scheme for laying a pipeline under the Black Sea cannot be realized. In fact, plans have already been reported for a new Russian gas line through Georgia to Turkey. Such a route would give Tbilisi even greater leverage as the energy crossroads of the Caucasus.

In the scheme of things, Georgia’s demands on Baku-Ceyhan may appear frustrating and small. But its own plans may be larger and could prove significant.