High oil prices likely to continue (page 1 of 2)

In its latest economic brief on the oil market and budgetary developments, National Bank of Kuwait reports the price of crude oil has been on an upward trend since the middle of June with Kuwait export crude averaging $25.126.6 per barrel in AugustSeptember, $0.751.5 above the July August average.

Increased likelihood of war in the Middle East has been cited as the key factor behind the steady rise in crude prices in the past few months. KEC continued to advance in September, averaging $26.5 by the middle of the month. Crude prices rose firmed further following OPEC's decision to keep its output targets unchanged in its most recent meeting on September 19.

Markets have priced a war risk premium into the price of oil
Increased likelihood of war in the Middle East has been cited as the key factor behind the steady rise in crude prices in the past few months. While Iraq's most recent announcement that it will allow the unconditional return of weapons inspectors could reduce the premium being priced into crude, the issue remains far from resolved.

The Oil market continues to consider a war on Iraq likely and pricinges a war risk premium of $2-$3 per barrel into crude prices. While Iraq's most recent announcement that it will allow the unconditional return of weapons inspectors could reduce the premium being priced into crude, the issue remains far from resolved.

Despite OPEC's recent meeting to keep output targets unchanged, the organization's production has continued to rise. Over-production has worsened with OPEC-10 producing as much as 9% above the 21.7 million barrels a day (mbd) target during August. With elevated prices the incentive to over-produce is high.

Furthermore, producers appear reluctant to call for more strict compliance with official targets given the relatively tight market conditions as consumers undertake precautionary stocking within an increasingly uncertain political environment.

Meanwhile, the demand picture has become increasingly pessimistic for the current year with growth of no more than 0.26% expected for 2002 as a whole by the International Energy Agency (IEA). The Centre for Global Energy Studies (CGES) expects growth to be half that. On the brighter side, analysts see more promise in 2003, with IEA expecting 1.4% growth next year.

Prices are expected to remain firm for the remainder of the year as likelihood for war looms higher. Given the great uncertainty about how events will unfold, there are multitudes of scenarios that can be conceived about oil markets, though not necessarily with equal likelihood.

Starting with a base case scenario of status quo and an average winter, we expect KEC at $25.3-$27.2 per barrel in 4Q02, and at $23.7-$24.2 for the year as a whole. A 0.5 mbd OPEC hike at the beginning of the year could keep prices from spiking in 1Q03, but KEC would remain above $23 per barrel. Any upside surprises in global demand for crude, such as a cold winter, could push prices higher.

If current attempts to defuse Iraq's dispute with the international community over weapons inspectors are successful and a US attack is averted, crude prices are expected to remain strong throughout 2003, with KEC averaging $25.8 for the year. Such a scenario would most likely be accompanied by a hike in OPEC production targets early in the year by 0.5 mbd, not enough to bring prices down to the lower end of OPEC's $22-$28 target price range.

In the event of a US strike on Iraq early in 2003, the impact on prices would vary.