Oil prices stronger than expected

In its latest economic brief on the oil market and budgetary developments, National Bank of Kuwait reports that oil prices strengthened in June with Kuwait export crude averaging $25.3 per barrel, nearly one dollar above the May average of $24.4.

This partly reversed weaker prices that followed the start of the war in Iraq. Prices increased as US refineries ran at full capacity to meet increased seasonal demand for gasoline during the summer months, pushing US demand for crude oil to record highs. Tensions in Nigeria have also helped push prices higher as supplies were disrupted.

According to the NBK report, however, most of the rise in the price of oil has resulted from the market's increased conviction that Iraqi oil production will not return to its pre-war levels as quickly as once thought.

Analysts initially supported the view that Iraqi production would return to its pre-war levels by the start of 3Q03. With the looting and chaos in Iraq the projection has been pushed further down the road to the start of 4Q03, with more delay still possible.

Meanwhile, oil stocks in industrial countries remain very low by historic standards. Despite a large upward revision in the April estimates of industry stocks by the International Energy Agency they remained at historic lows standing at 52 days of oil demand, 4 days below their level a year before.

Despite low oil inventories, the mood at OPEC is to cut production rather than to add extra barrels to the market. Still, at its June 11 meeting the organization decided against a further cut in production ceilings after members were convinced that the resumption of Iraqi production and exports will take more time than first thought.

NBK projects that if Iraqi crude production does not return to its pre-war levels until 4Q03 we can expect Kuwaiti crude to stay near $24 per barrel for the remainder of the year, thus averaging about $25.2 for the year as a whole.

Under such a scenario OPEC would keep output unchanged during 3Q03, then boost it in 4Q03 to meet the increased seasonal demand at the start of winter in the northern hemisphere.

If, instead, OPEC decides to focus on defending its market share, which has dwindled in recent years, by boosting output in 3Q03 NBK expects to see oil prices weaken somewhat during the second half of 2003 to average $20 by 4Q03 and $24.3 for the year as a whole.

However, for fiscal year 2003/2004, the average would be even lower at $22.1. This scenario is not very likely as all signs continue to point to a commitment by OPEC members to the strategy of keeping the benchmark crude oil price within a desired range.

On the upside, given the difficulty in predicting the resumption of Iraqi crude production, it is possible that pre-war levels will not be seen this year at all.

In such a case, the market will tighten more quickly and cause prices to average $27 in 3Q03 before being assuaged by an OPEC production hike in 4Q03, yielding an average price of $26.4 for KEC in 2003 as whole.

Under the scenarios presented above, the price of Kuwaiti crude is likely to average $22.1-$25.8 during fiscal year 2003/04. As a result, government revenues are likely to be KD 5.17-6.14 billion.

This will exceed by 45%-70% the KD 3.56 billion expected in the draft budget. If the government spends the entire KD 5.83 billion in budgeted expenditures, NBK expects a KD 311 million surplus under the high price scenario or a deficit of KD 180-659 billion in the other two cases.

However, NBK expects expenditures to come in about 10% below budget, or KD 5.36 billion, which means the budget could still see a surplus of KD 286-777 million in the higher price scenarios. In the extreme case of OPEC seeking to defend its market share leading to higher production and lower prices, a small deficit of KD 193 million is likely.