By Mark Goetz

Surging demand and political turmoil have kept the market nervous. Despite increased production and the promise of more crude to come, confidence in security of supply is low.

Growing global demand and high prices brought on by fears pertaining to security of supply prompted OPEC to open its taps in early June when it met in the reconstructed Lebanese capital of Beirut. Western countries, particularly the members of the G-8 – in the face of record crude oil prices – had urged OPEC to increase its output or risk ruining the prospects of global economic growth.

Click here to enlarge image

OPEC responded with a pledge to raise its official OPEC-10 (without Iraq) production quota through a two-stage increase: by 2m bbl/d from 1 July to 25.5m bbl/d and by a further 500 000 bbl/d by August to 26m bbl/d. Meanwhile, OPEC members are unofficially pumping beyond their quota allocations and production for the OPEC-10 during May was estimated at 26.1m bbl/d. An additional 2m bbl/d from Iraq put the total volume of OPEC crude on the market during May at 28.1m bbl/d. Plans by Saudi Arabia to increase output by an additional 1m bbl/d during June will bring OPEC production at more than 29m bbl/d for the month.

Despite OPEC members’ current over-quota production and the promise of more crude to come, the market has failed to find the confidence in security of supply that it has been looking for. Continued violence in Iraq, where export pipelines remain a prime target to insurgents, and growing violence in Saudi Arabia have served to keep NYMEX prices in a range near $40/bbl. Furthermore, political turmoil in Venezuela, Nigeria and a strike by oil workers in Norway, have helped to keep the market jittery, and it is expected to stay on edge until a time comes when stocks are considered sufficiently rebuilt – perhaps later this year.

The problem that the market now faces has been building for some time. OPEC’s efforts to avoid over-supplying the market in order to keep prices within a $22-28/bbl range have proved to be too effective, and the tight market has been compounded by a fear factor that some traders say adds as much as $5/bbl to the price.

In the US, where prices reached an all-time high of $41.72/bbl in late May, gasoline demand has been climbing as more SUVs take to the highways and the US has found itself ill-prepared to meet the demand for auto fuel. The fall in the value of the dollar, plus efforts by OPEC producers to compensate themselves with higher prices for dollar-denominated barrels, has also played a significant role in keeping prices higher than what OPEC itself now deems healthy.

With the market reacting to almost every news bulletin, assurance of supply is the key to getting prices down to a range that global economies can tolerate. Violence in the Middle East led the US government to announce in late June that if a terrorist attack should disrupt supplies from Saudi Arabia, it would consider releasing oil from the Strategic Petroleum Reserve (SPR), which has itself been a contentious issue in recent months. The Bush administration has received harsh words from its critics for continuing with its policy of buying 120 000 bbl/d of crude for the SPR while prices are high. Critics say the crude bought for the SPR should be moved into the domestic market. The US is now importing crude at an average of more than 10m bbl/d.

OPEC’s own concern for adequately supplying the market and getting prices under control was also revealed in late June when the group’s president Purnomo Yusgiantoro said the organization would formally request that Russia, Mexico, Oman and Angola increase their production in order to curb rising prices. Russia, with output at more than 9m bbl/d, has reached a production level to rival Saudi Arabia’s, but it lacks the export capacity to put more crude on the market.

But while violence and political turmoil keep the market nervous, the fundamentals of demand and supply continue to have their role to play. Demand is surging in China and India as well and it continues to edge upward in the US, where gasoline remains tight and will inevitably remain so throughout the summer.

Click here to enlarge image

OPEC has increased its projections for global demand during 2004 to 80.58m bbl/d, according to its June Monthly Oil Market Report. The call on OPEC crude for the year is expected to average 26.73m bbl/d, while non-OPEC supply is estimated at 53.85m bbl/d. The report speculated that by the end of the year, demand could reach world total production capacity. However, the report predicted a stock build of 2.3m bbl/d during the fourth quarter of 2004, disputing the argument that a supply disruption for whatever reason could result in severe consequences for the market.

Meanwhile, in its June Oil Market Report, the International Energy Agency (IEA) put world crude demand for 2004 at 81.1m bbl/d, with OPEC supplying an average of 26.9m bbl/d and non-OPEC producers supplying 54.2m bbl/d.