Mixed signals remain about market outlook

OPEC Bulletin Commentary June 2009

The 153rd (Extraordinary) Meeting of the OPEC Conference came and went on May 28.

It produced no surprises, instead consolidating the production agreement reached in Algeria in December and reaffirmed in Vienna three months later, on March 15.

It took place at a time of mixed signals about the outlook for the oil market in the coming weeks and months, with a widely perceived imbalance between strengthening spot prices and weakening fundamentals.

Nevertheless, compared with the March meeting, there had been a positive shift in the nuances of the language used to describe the oil outlook. This was well summed up by the changing tone of the feature article in our Monthly Oil Market Report. In May, its heading of ‘Economic downturn slowing, but real recovery to come’ was decidedly more upbeat than ‘Economic uncertainties still overshadowing the oil market’ two months earlier.

In other words, while there was still much gloom in the global financial community and real economy — key drivers of the energy sector — there was, albeit, less pessimism around than ten weeks earlier. Indeed, some recent positive indicators were pointing towards the possibility of the recession bottoming out before the end of the year.

However, at the same time, with weak industrial production, shrinking world trade and high unemployment, optimism was in short supply too, and oil producers, like everyone else, were sensitive to this.

By the start of the May meeting, oil prices had risen steadily to $61/barrel for OPEC’s Reference Basket, compared with a more settled $44/b at the start of the previous meeting.

While this had brought prices closer to levels that could support sound investment plans for future production capacity — around $70–80/b — it had also distanced them further from supply and demand fundamentals.

This was — and remains — a matter of concern to OPEC, as we made clear at the Conference.

We do not want a repetition of the chaotic volatility of 2008, with its unsustainable peaks and troughs, brought on by unfettered speculation on a massive scale by non-commercial interests.

Furthermore, prices have continued to rise since the Conference, passing the $70/b mark, even though the crude oil volumes entering the market continue to be higher than demand and OECD commercial oil stocks are still well above their five-year averages.

On the demand side, there has now been a ten-month period of almost unbroken downward revisions to our world oil demand forecast for 2009, with a total fall of four million barrels/day from 87.8m b/d last August.

This combination of events defies simple market logic and highlights a profound dilemma.

On the one hand, higher prices are needed to help foster stability, by supporting investment in production capacity to meet the forecast, post-recession rising demand.

On the other hand, they are being driven, at the moment, by the very phenomenon they are trying to counter, namely volatility — that is, the volatile behaviour of speculative forces that are once again prominent in the market.

Stability and volatility are opposites. They cannot coexist in a well-functioning market. This is not sustainable. Prices driven up by speculation can just as easily fall through speculation, as we saw last year, to our cost. They can also soar to untenable levels, as again witnessed in 2008.

As a result of all this, the oil market is now in a delicate and precarious state, and a comparatively minor impulse could tip it one way or the other.

OPEC, like other players in the industry, is adopting a cautious, wait-and-see attitude over the market outlook. There are still many risks and uncertainties at large in the global economy, in the face of the ongoing recession, as was noted by the Group of Eight’s finance ministers in Italy in mid-June — although they did point out, at the same time, that the world’s largest economies were beginning to stabilize.

We are prepared to act — at short notice, if necessary — by adjusting our production agreement in a pragmatic, calculated manner, if our constant monitoring of developments suggests that this will be in the best interests of market order and stability.

Otherwise, we shall continue to wait and see how things develop in the world economy and especially the financial sector.

This Commentary is taken from the June 2009 edition of the OPEC Bulletin, which can be downloaded free of charge in PDF format from the OPEC website.

OPEC Bulletin (June 2009)

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