A.G. EDWARDS & SONS, INC.
One North Jefferson, St. Louis, Missouri
314-955-3050
(March 9, 2000) ENERGY COMPLEX: Oil prices have reached their highest level since the Persian Gulf War. Much of the rise has been blamed on OPEC, with commentators suggested "remarkable compliance" to quota. For the most part, this has never been true; half of OPEC has been overproducing for the last 12 months. However, as we have shown numerous times, "major OPEC," i.e., Saudi Arabia, Kuwait, Iran, Venezuela and the UAE, have held reasonably close to quota, while the rest of the cartel has been allowed to overproduce. However, recent data suggests even major OPEC is boosting output.
OPEC Production
This table shows Bloomberg's estimate of production for the cartel. Until last month, major OPEC has held production to under 3% of quota. Compliance among the major OPEC members has seriously deteriorated. Conformity to quota has been poor among the minor OPEC countries, having exceeded quota by 5% or more most months.
In February, total overproduction was nearly 1.1 mbpd above quota. In addition, Iraqi production rebounded by nearly 0.4 mbpd, putting total OPEC output at 26.6 mbpd, up 0.6 mbpd from January. The data suggests rather strong OPEC production, and yet, despite this extra oil, prices remain strong. There are two potential explanations for the market's easy absorption of the oil; either demand has increased, or non-OPEC supply has fallen, or a combination of both has occurred.
U.S. Weekly Crude Oil Inventories
This chart shows U.S. oil inventories for the period beginning in March 1999. Storage peaked in April of last year, and has fallen steadily since. During February, U.S. crude oil storage rose 3.4 mb from the end of January. Meanwhile, refinery operations were essentially unchanged from the end of January until the end of last month.
Refinery Runs
From the beginning of the month, runs are up 0.4 mbpd. This is not a significant increase in consumption. As refineries return from maintenance, runs rise to near 100% of capacity during the summer. Thus, we can expect a steady increase in consumption toward 15.5 mbpd by mid-to-late summer, a 1.3 mbpd rise. Assuming the U.S. is a good proxy for the world market, the rise in OPEC output during February, coupled with the lack of an increase in crude oil storage and the modest expansion of refinery runs suggests non-OPEC oil production is still lagging. In our estimation, this is the real mystery of the past year. Normally, with prices this high, one would expect rapidly rising non-OPEC output. Since this has not happened, OPEC has a rare opportunity at the end of March to boost output and gain market share.
We expect OPEC will increase quotas modestly at the March 27th meeting. Our 2000 estimated call on OPEC crude oil is 28.2 mbpd. Based on current production, OPEC needs to add 1.6 mbpd to stabilize the market. If we assume steady production from Iraq and Saudi Arabia, the remaining excess capacity would only be 1.9 mbpd. Essentially, if Saudi Arabia maintains a quota of 7.7 mbpd, and allows near full production from the rest of the cartel, the world inventory situation would merely stabilize.
If OPEC increases output by 1.5 mbpd or less, prices will probably fall initially, mostly a psychological reaction to the news. However, an increase of this magnitude will not improve the supply situation, and prices will likely remain in the $25 to $30 range, with a bias toward the high end of the range. Assuming this level of output, we should see some weakness into autumn, with potential for higher prices in the fourth quarter. As a pre-OPEC meeting trade, we are long October/short June crude at 3.46 (ob) premium in June, risking to 4.21 with an objective of 50 cents.
Bill O'Grady