Oil and budget deficits from NBK

In its latest economic brief on oil markets and budget developments, National Bank of Kuwait reports that world oil price forecasts for the second half of 2001 have been adjusted upwards following OPEC's June meeting during which producers decided to hold output steady.
Constraints on the downside risks also appear firmer despite a steady buildup in inventories of both crude and refined products relative to a year ago as stock levels remain generally low. Our forecast for Kuwait export crude (KEC) for 2001 has been raised by $1.4 to $23.8 per barrel, while the average KEC price through the end of May edged up to $22.6. Currently it is trading above May's average of $24 a barrel.
The persistent strength in oil prices comes amid concerns over growing imbalances between supply and demand this coming summer. Competition for crude by refiners coming out of maintenance is expected to intensify in the coming months. Meanwhile, Iraq halted its exports in protest of the one month extension of the oil for food program as the UN security council discusses proposed changes in the sanctions on Iraq and the program itself.
Even though OPEC signaled its readiness to ease supply in July should Iraq continue to hold back exports, any action is more likely to maintain global supply levels than effectively raise it to accommodate the higher seasonal demand.
Despite a strong crude oil market, a number of factors have tempered the surge in prices and were probably behind OPEC's decision against a much-called-for hike in output. One such factor is that OPEC output has not actually fallen by much since the start of the year.
The reasons include the over-production of some member-countries and the resumption of Iraqi crude exports in February. Though the OPEC-10 production ceiling was cut by 2.5 mbd during the first four months of 2001, actual production fell by only 1.9 mbd and most of this drop was eaten away by an increase in Iraqi output. As a result, total OPEC reductions since the start of 2001 were a mere 100,000 barrels.
Another factor has been the apparent weakness in demand during 2001. Initial IEA estimates for demand in 1Q01 came in well under expectations and both CGES and IEA have tempered their forecast of demand growth in 2001 to 1.3%, down from 2.3% in January.
All this has helped the industry rebuild some inventory during 4Q00 and 1Q01, though levels are still below 1998 highs. IEA estimates that global supply has exceeded demand since 2Q00. Moreover, OECD inventories showed year-on-year increases in 4Q00 and 1Q01, with OECD stockcover up by 1.5 days during the last year. OECD stockcover has not shown a year-on-year rise since 3Q98.
Notwithstanding the increase in stockcover, weaker demand, and minimal real reductions in OPEC production thus far in 2001, oil inventories remain at low levels. This means that higher seasonal demand during 3Q01 should be met with an increase in OPEC output sometime in the coming months to avoid a large surge in prices.
If the organization chooses to implement a hike in September, KEC could average $22.6 per barrel in 2001. A hike in October would push the 2001 average higher to $25. The range for the fiscal year 2001/2002 will be slightly wider between $22.1 and $26.3.
Despite continued strong oil prices, it looks unlikely that Kuwait will be able to see a budget surplus as large as the KD1.7 billion surplus estimated for the 2000/01 fiscal year. Two reasons are behind this.
First, if the draft budget being considered by parliament is approved, growth in government spending could be as high as 12% during fiscal year 2001/02 on an annualized basis. Second, the drop in Kuwait's oil production level will reduce government oil revenues on an annualized basis.
The government budget could be in deficit of some KD105 million if the price of KEC comes in at the lower end of our forecast for the fiscal year 2001/2002 and actual spending comes in at budget.
A more likely scenario is for the price of Kuwaiti crude to stay above $24 per barrel and spending to come below budget. This implies a possibility of a budget surplus between KD0.75 and 1.25 billion.