Low stocks and downstream refinery capacity constraints will keep oil prices
high and volatile unless Opec relaxes its grip or recession starts to bite.
The oil market faces another difficult year despite growing concerns about the global economy. Prices are already at record levels, reflecting last year’s tightening fundamentals. Industry stocks are down sharply compared with a year ago, adding to pressure on refiners as they strive to keep pace with growing demand for transport fuels. Yet Opec is reluctant to let stocks rebuild to more comfortable levels this year lest prices collapse.
Opec is engaged in a precarious balancing act. If it maintains its tight grip on supply, oil prices could spike, tipping the global economy into recession. But if it relaxes its grip, oil prices could slide, reversing the revenue gains of recent years. Output has already risen sharply after Opec was forced to concede that more oil was needed to meet peak winter demand because stocks were low. But Opec must now decide whether to let industry stocks recover next quarter as demand falls seasonally — and risk a price fall — or cut output to keep stocks low and risk a price spike.
Opec’s problem is that oil demand is now disconnected from supply because refiners cannot easily match crude supply to final product demand. With demand for transport fuels still growing strongly and demand for heating fuels shrinking, refiners must either upgrade the mix of products that they make, or run more crude and dispose of the surplus residue. But, because surplus residue competes with crude as a refinery feedstock, Opec needs to ration the supply of crude to avoid undermining its own market — as happened in the fourth quarter of 2006, when oil prices plunged after a surge in refinery runs created a stock overhang.
Oil demand rose by just over 1mn b/d (1.2pc) last year, according to Argus estimates, but crude supply fell by 100,000 b/d as refiners drew down stocks and recycled surplus residue through upgrading plants. Steep cuts in Opec crude production were only partially offset by higher non- Opec and Opec NGLs supply. Demand for transport fuels in the group of 14 countries that Argus monitors grew by nearly 3pc last year, and demand for heating fuels fell by 11pc. This meant that the pressure on upgrading capacity intensified, helping sustain the upward trend in oil prices.
Until investment in refinery upgrading capacity catches up with demand for lighter cleaner products, Opec will be unable to balance the market. The industry met demand growth from stocks last year, but it will be difficult to draw down industry stocks further as they are already close to historical lows. Forward cover provided by OECD industry stocks was already below 52 days at the start of this year, so Opec needs to boost crude supply to meet faster growth in transport fuel demand and avoid further price spikes. But this risks triggering a sharp price fall once surplus residue accumulates.
Opec is coming under increasing pressure to raise output to reduce oil prices and avoid the risk of recession. US president George Bush added his voice on a visit to Saudi Arabia, but Saudi oil minister Ali Naimi said he expects inventories to recover in the second quarter. With its output likely to exceed the call on Opec crude by 1mn b/d in the second quarter, according Argus forecasts, the organisation faces a real dilemma when it meets next month. What the economy needs is a stockbuild and lower oil prices. But what Opec wants is stable inventories to defend high prices.
