The OPEC Ministerial decision to cut production levels by 1.2 mb/d effective 1 November 2006 appears to have largelyachieved its purpose of stabilizing markets and arresting the sharp fall in oil prices seen the last few months. Prior to theMinisterial Meeting, OPEC Reference Basket had plunged 27% from a peak of $72.68/b on 8 August to $53.37/b on 31 October. However, since then the Basket has fluctuated within a narrow range of $53-56/b. Although the Basket price seems to have somewhat stabilized, the recent sharp fall in prices may indicate the end of the steady bullish phase that has characterized the market since 2004. If so, then it would be important to get an indication of what this new transitionalphase might entail. So far, this transitional period appears to be marked by a slowdown in global economic growth, downwardrevisions in oil demand growth, plentiful stocks and a surge in non-OPEC supply.
Additionally, speculators continue to have an impact on the crude market in the period of falling prices. The behaviour of noncommercials may have contributed to somewhat exacerbating price trends, this time on the downside. However, although thefall in net long positions of non-commercials since August mirrored the drop in the prompt oil prices, open interest has remained undiminished, indicating unbroken flows of funds into oil futures markets.
As for market fundamentals, the most likely outcome for the world economy next year remains a moderate slowdown to agrowth rate above 4%, but the growing uncertainties surrounding the US outlook mean that the possibility of a sharper downturnshould not be overlooked. While the developing world continues to exhibit robust growth, in particular China – albeit with some signs of a possible soft-landing – the noticeable drop in third-quarter US growth highlights the risks surrounding the global short-term economic outlook. Recent US data indicates that the weakness in the US housing sector and in manufacturing may be spreading to the economy as a whole. The Japanese economy also slowed in the third quarter despite the strong performance of the corporate sector. Data from the European region has been more encouraging. However, it is unlikely that European consumers will be able to generate self-sustaining growth in the region, if the US and Japanese economies weaken in 2007.
At the start of the winter season in the US Northeast, the fall in heating oil inventories in the last four weeks has triggered some concerns about the adequacy of these seasonally important stocks. However, a closer look at US data reveals that despite the consecutive draws on heating fuels, stocks remain 15% higher than a year ago and 10% above the average for the last five years. This recent drop in heating oil stocks can be attributed to a fall in production as well as imports, reflecting the typical refinery maintenance cycle at this time of year, rather than an indication of any shortage in crude supplies. Indeed, US crude stocks have continued to rise and are presently 11% higher than five-year average and 4% above last year’s level. Similarly, global inventories are plentiful as shown by OECD total commercial stocks at the end of September, which were 29 mb above the previous month and 6% higher than the average of the last five years. This translates into 55 days of forward cover, two days more than last year when stocks were generally considered by the industry to be more than adequate. Moreover, OECD commercial stocks levels are currently the highest since November 1998, with the stock-build averaging 1.2 mb/d, the biggest 3Q increase since 1991. As the OPEC cuts begin to take effect, some fall in crude inventories is bound to be observed, however, it should not strongly impact the overall healthy picture.
On the demand side, the wide range of forecasts for 2007, generally between 1.1 mb/d to 1.6 mb/d, is indicative of theuncertainty surrounding the outlook for the rest of this year and next, with OPEC estimating a 1.3 mb/d increase in 2007. This mirrors both the ambiguous global economic prospects as well as the dynamics of oil demand growth in developing countries. On the supply side, the net outlook remains exceptionally bullish next year despite widespread revisions to non-OPEC supply, with an expected increase of 1.8 mb/d for non-OPEC supply, unchanged from last month. This indicates a drop in the demand for OPEC oil in 2007 of around 0.7 mb/d, an imbalance which the OPEC decision at Doha was aimed at redressing.
Looking forward, if OPEC-10 were to continue producing at the agreed level with Iraq output at around 2 mb/d, this would leadto a build of up to 1.4 mb/d in the second quarter of 2007, compared to a typical build of 1.1 mb/d. This continuation of aboveaverage stock levels may point to a further imbalance in supply/demand fundamentals. Incoming data will provide furtherindications of market trends in the coming weeks and serve as key inputs for discussions at the upcoming Meeting of theConference scheduled for 14th December in Abuja.
