Opec changes strategy (page 1 of 3)

Oil prices soar and OPEC changes strategy

WTI oil prices topped USD57 per barrel in March as the markets looked beyond bearish short-term fundamentals to potential stronger demand in Q4. High prices have forced OPEC to change strategy and allow higher inventory levels. Before 2004, OPEC managed the market by adjusting output to control global stock levels.

With a small margin of spare capacity, and the ongoing possibility of supply disruptions, this is no longer feasible. OPEC is consequently raising output now ahead of a period of weaker demand to avert tighter conditions in Q4.

This has not yet led to a price decline, as it has narrowed excess capacity even further, but it should lead to softer prices as inventory build becomes clear.

Speculation is an issue... but its also demand

Speculative activity is having a significant impact. Data from the Commodity Futures Trading Commission (CFTC) in the US shows net open positions on the NYMEX, an indication of speculative activity, more than doubling in the last month to a peak of over 76,000 contracts on 8 March.

Net open positions fell in the following week as short positions increased, supporting the view that the market is due for a correction. Prices will likely correct from this peak but stay high, despite bearish short-term fundamentals, on three concerns.

First, doubts over OPEC's ability to continue raising output to meet stronger future demand. Second, a lack of clarity on OPEC's price aspirations. Third, the quality of the oil, hence widening differentials between crudes.

OPEC does have limited spare capacity

OPEC raised OPEC-10 quotas (which exclude Iraq) by 0.5 million barrels per day (mbd) to 27.5mbd in March, still below OPEC's estimate of current output at 27.7mbd, and is discussing a further increase to 28mbd.

Assessments of OPEC's capacity vary. The International Energy Agency (IEA) puts OPEC-10's sustainable capacity at 28.5-29.0mbd and spare capacity at 0.8-1.3mbd. Bloomberg estimates (see ) put both capacity and output higher, with a gap of 1.7mbd in February, but the message is the same.

OPEC has sufficient capacity to meet current demand but not enough to cover unforeseen supply shocks and/or rising demand. The recent Nigerian strike threat has brought the risk of supply shocks firmly back in focus.

The China factor

Oil demand growth was an exceptional 2.8mbd (3.5%) in 2004, on the back of robust global GDP growth.

China accounted for 0.9mbd of the increase, as demand rose by 15.9%. This was partly strong GDP growth (which averaged 9.3%), but also a result of severe power shortages raising diesel demand for generators. This specific factor should ease this year.

China's net imports of crude oil and refined products, which rose by 41% and 83% respectively in 2004. For 2005 we expect China's oil demand growth to be more commensurate with China's expected GDP growth of 8.5%. China is also building a strategic oil reserve, but the first part of the storage infrastructure will not be complete until later this year.

US demand growth is strong, but easing

The US is still the key driver of the oil market, accounting for 25% of global demand, compared to China's 7%. US GDP growth will still be strong in 2005, but should moderate to around 3.5% from 4.3% in 2004.

Consequently we expect more modest global oil demand growth of around 2mbd in 2005 (above the IEA's current forecast of 1.8mbd and OPEC's 1.9mbd).