Kuwait revenue $20bn, $3.5bn surplus

In its latest economic brief on the oil market and budgetary developments, National Bank of Kuwait reports that geopolitical developments have pushed the price of Kuwait export crude (KEC) above $30 a barrel since mid February, putting it almost 40% above its lows in November 2002.

The surge in oil prices that started in December was fuelled initially by disruptions in Venezuelan oil exports, but gained added momentum on rising concerns over the inevitability of war in Iraq.

Uncertainty has been the biggest factor in the recent run up in oil prices. Increased likelihood of a US-led attack on Iraq by early spring at the latest has heightened fears of a substantial disruption in the Gulf region's oil exports, bringing back a war premium to oil prices.

In addition to losing Iraqi crude in the event of a war, the markets have been reacting to the small likelihood that other suppliers in the Middle East, primarily Kuwait, could also be affected, at least temporarily.

Still, the rise in oil prices has as much to do with supply fundamentals as it has to with the increased uncertainty in the region. Despite OPEC's surge in production following its decision to hike output targets in January, the market has tightened substantially thus far in 2003. The main factor behind this has been the loss of much of Venezuela's crude supply on which the US market relies heavily.

Time lags involved in replacing this short-haul crude with long-haul Middle Eastern crudes has caused US stocks to drop to their lowest levels in two decades. Tight conditions are expected to continue despite the gradual restoration of Venezuelan crude production during February. The latter is expected to take some time before reaching pre-strike levels again.

NBK states that increased demand has also been an added factor boosting the price of oil. Winter demand has been stronger than expected due to colder than usual weather in the US and to increased fuel consumption in Japan's power sector as the country faces some problems with its nuclear power plants. This has added strength to an already improved demand growth picture for 2003 relative to 2002.

The International Energy Agency (IEA) expects growth to reach 1.43%, versus 0.52% last year. However, continued high prices could put a damper on these expectations.

The Centre for Global Energy Studies (CGES) estimates that the increase in OPEC production suggests a global stock build of 1 mbd in 1Q03. However, much of the additional oil is still at sea or in producer-controlled storage, with little impact on US inventories that are close to their operational minimum. CGES expects some of this additional oil to arrive at the US in the second half of March, which should ease prices.

Excluding Iraq, the supply picture is expected to improve further in spring. OPEC producers are expected to continue boosting their production in anticipation of a disruption in Iraqi exports and to give assurances to markets and consumer governments of its ability to meet demand in the hope of dissuading them from releasing strategic stocks.

Kuwait has been trying to set aside concerns about its production capacity by announcing that actual production is running at full capacity of 2.4 million barrels per day (mbd) despite the fact that it shutdown production in its northern-most fields, with production of around 0.1 mbd.

The NBK reports that prices are expected to remain volatile this year with a multitude of possible scenarios concerning the geopolitical situation, OPEC supplies, possible release of strategic stocks by the US and other OECD countries and global demand. The range expected for KEC for 2003 falls between $21 and $28 per barrel, while the estimate for the fiscal year 2002/03 ending in March is around $26.

NBK's middle case scenario assumes a short and contained war in Iraq lasting a couple of weeks and little if any disruption in oil supplies. Following an initial modest release of US strategic stocks and an increase in OPEC production to reduce tight supplies and counter war disruptions in 2Q03, the organization would be expected to reduce output thereafter. In such a case, KEC is expected to average $29 during 1Q03.

Subsequently, prices should begin to soften in 2Q03 along with the seasonal drop in demand, and average between $20 and $25 a barrel for the rest of the year, and $23.8 for 2003 as a whole. This risk of war could be higher if Iraq or other events succeed in disrupting the flow of oil from the Gulf, or if the military campaign is prolonged.

The use of strategic reserves in OECD countries can make up for the shortfall, but oil prices would nevertheless stay high past the middle of the year. Though Brent is likely to stay above $30 most of the year, NBK did not consider this scenario for estimating KEC prices given the uncertainty concerning the country's oil exports under it.

The higher price scenario NBK considers is one where war continues to be delayed beyond the spring. Uncertainty in oil markets would continue to place a premium on oil prices until the threat of invasion subsides completely. OPEC would still be expected to hike production in 2Q03 to ease market tightness, before cutting back production later in the year. KEC would likely average $29.2 in 1Q03 before declining to under $27 later in the year and averaging $28.1 in 2003.

Though the 2003 demand growth forecast underlying the previous two scenarios is quite modest at 0.8%, even this could prove to be too optimistic. The possibility of still weaker demand during 2003 looms as economic recovery in industrial countries remains elusive. In such circumstances, and assuming the impact of the Iraq situation on the flow of oil from the region is contained, OPEC can be expected to implement bigger cuts in production. Faltering demand growth could depress prices in NBK's low case scenario to $16-$19 later in the year, with KEC averaging $21 in 2003.

Oil prices could also tumble even under the current demand picture. The release of substantial amounts of strategic stocks shortly after the war starts, possibly in April, could cause a sudden glut in oil and a collapse in prices if the war is short and conclusive. This is what OPEC is trying to avoid by reaming up production even as we approach a seasonally weak demand period in the second quarter.

NBK expects Kuwait export crude to average $26 during the 2002/03 fiscal year that ends in March. Budget revenues that totaled KD 5 billion over the first ten months of the fiscal year could top KD 6 billion by end March. This could be a record reported by Kuwait.

If actual expenditures are at budget with spending reaching KD 5.43 billion, the government budget would see a surplus of KD 638-657 million before appropriating 10% of revenues for the Reserve Fund for Future Generations (RFFG). However, we can expect spending to come in 8-10% under budget as it has done in the past. Consequently, we forecast a higher surplus in the range of KD 960-1,177 million.