Oil Prices Rise as Saudi Comments over Output Fail to Reassure

Assurances by OPEC kingpin Saudi Arabia that it would respond to market tightness by boosting production as and when needed appear to have been overshadowed by news over the weekend of further production problems in Nigeria. Despite having fallen to as low as US$131.75/b, the NYMEX August crude futures contract went on close at US$135.36/b—up US$2.76 on the day. In London, the ICE Brent oil contract for August delivery also jumped, closing at US$135.40/b—up US$2.71/b.

The upward shift in prices appears partly driven by events in Nigeria over the last few days, with reports of Chevron declaring force majeure on around 120,000 b/d of output as a result of sabotage against an oil pipeline. The supermajor has also been facing a labour dispute that is threatening to affect the company's entire 350,000 b/d of output in Nigeria. Furthermore, an attack by oil militants on Shell's Bonga oilfield facilities last week resulted in the company being forced to shut in around 225,000 b/d of output. In a sign of how dire the situation has become, a senior Nigerian official has commented that the country's total oil production is now running at between 1.2 million b/d and 1.5 million b/d—a 25-year low.

Jeddah Summit Short-Term Disappointment

The summit in Jeddah between oil producers, consumers, and high-level representatives of the oil industry initially seems to have received a cool reaction from the world crude markets. While Saudi back-channel diplomacy had managed to raise expectations of the meeting's ability to deliver on a concerted international effort to bring down spiralling crude prices and rein in market volatility, only Saudi Arabia itself produced any concrete offer of added production capacity. Indeed, some OPEC nations even threatened to withdraw production, viewing the Saudi offer as stoking a possible over-supply of the market.

Saudi Arabia confirmed its latest pledged 200,000-b/d production increase from July, while Kuwait and the United Arab Emirates reiterated their abilities to raise production "should they be called upon by the market to do so", Agence France-Presse (AFP) reported. The biggest news was the Saudi revival of its long-term commitment to raise output capacity by an additional 2.5 million b/d, from 12.5 million b/d to 15 million b/d by 2018, an investment programme that had been scrapped in recent months. Saudi Arabia is currently finalising a programme to increase its production capacity from an official 11.3 million b/d to 12.5 million b/d by mid-2009. The added capacity in the second-stage extension programme would be sourced almost entirely from five specific fields: Zuluf (900,000 b/d); Safaniyah (700,000 b/d); Berri (300,000 b/d); Khurais (300,000 b/d); and Shaybah (250,000 b/d). The second-stage increase was earlier put on ice, as the kingdom said it did not see world demand climbing to such levels in that amount of time. Launching the second-phase production capacity extension would, however, still be subject to studies on whether future oil demand would warrant the huge investments, Saudi Oil Minister Ali al-Nuaimi told media, indicating several times that a full commitment by the kingdom to pursue the long-term programme was still lacking.

Doubts with Producers Continue

Further near-term production increases by Kuwait and the United Arab Emirates were also cast in doubt, as national oil industry insiders quoted by AFP said the de facto spare capacity of United Arab Emirates' main producer, Abu Dhabi, currently only stood at around 150,000 b/d. They also said that Kuwait only could sustain an added production of 100,000 b/d during a shorter term. Both the United Arab Emirates and Kuwait, together with Saudi Arabia, are currently suffering a gas crunch, which—to compound global fears of crude market tightness—has forced the countries to increase their use of crude for electricity generation, as well as occasionally divert gas from crude production-supporting gas-injection programmes to electricity plants, hurting oil output. As the summer peak-demand period is intensifying in the region, this might cause further production instability.

OPEC Disunity

After having threatened to snub the meeting, Venezuela did in the end attend the high-profile summit, sending Oil Minister Rafael Ramirez to Jeddah. The volte-face indicates how strongly Saudi Arabia wanted the summit to convey unity on the OPEC oil-producer side and was most likely a result of strong back-channel negotiations between the countries. Nevertheless, OPEC continued to send out contradicting signals during and after the meeting, and ultimately the summit did not achieve the Saudi goal of a new OPEC consensus about the need to add production in order to lower prices. Algeria's Energy Minister, and OPEC's current chairman, Chakib Khelil, continued to affirm that global supply and demand are in balance and that speculation and a falling U.S. dollar were at the root of the price increase, with Libya's Oil Minister Shukri Ghanem going as far as saying that Libya—seeing no market need to add production—might consider lowering production by a corresponding amount to the Saudi increase, in order to keep the supply-demand balance intact, Bloomberg reported. Khelil went as far as telling AFP that he could not see prices recede because of the conference, while talks were in full swing yesterday, undermining the Saudi efforts to reassure the markets.

Long-Term Efforts, with Uncertain Impact

The resulting final declaration agreed upon by the converging consumer, producer, and industry representatives showed an attempt to co-ordinate international co-operation over the high oil prices, but has generally been received as lacking in concrete measures. A concerted view over market speculation being culpable for the spiralling prices failed to emerge, although a need to "study" the role of the futures market's impact on fundamental prices was agreed between the parties, as well as a call for greater regulation and transparency in the activities of index funds on the commodity markets.

Outlook and Implications

The absence of very concrete suggestions and policies emanating from the Jeddah meeting is likely to result in market disappointment in the short term. Saudi Arabia has failed to address the most critical issues levied against the OPEC oil producers: the lack of reserve data transparency and the lack of disclosure of how much non-heavy-oil added production capacity they actually have. With most of the OPEC spare capacity now being made up of heavy oil, with which the world market appears saturated, the perceived market tightness looks set to continue for some time, unless the now-promised added flows of light and medium crude from the Khursaniyah field in July on their own manage to make the necessary impact. Saudi Arabia is the only country within OPEC that has the ability to bring any substantial additional volumes to market, with an implied spare capacity cushion of around 1.5 million b/d. Nonetheless, the kingdom's output expansions are years away.

One of the popular reasons given for the 40% jump in oil prices this year has been the continued strong growth of Asian economies such as China and India, but that growth has partly been sustained by a policy of subsiding fuel prices and so shielding consumers from paying full global market rates. The oil-price jump has been so pronounced, however, that even these economies are being forced to cut subsidies as their budgetary costs become unbearable amid fears of inflation. As a result, several Asian governments, including—surprisingly—China, have decided to raise fuel prices in order to rein in the otherwise spiralling costs of keeping the policy in play. As such, demand growth from the region is expected to fall in future. The medium-term outlook therefore appears to be more bearish, amid warnings of falling fuel consumption even in the United States, the world's largest economy.

As is evident from the recent direction of oil prices, however, the market appears to be focusing its attentions on short-term factors, and in this regard, disruptions to supply are particularly relevant given the recent negative oil production news from Nigeria. This, along with continued sabre-rattling by Israel towards Iran, seems to be contributing to the particularly bullish sentiment at play this morning. At the time of writing, the front-month NYMEX futures contract was trading higher at USU$137.19/b—up 1.35%.

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