What will oil do in 2010

Written by Kaushik Ranjan Bandyopadhyay | Updated: Dec 30 2009, 14:19pm hrs
The Organisation of the Petroleum Exporting Countries (Opec) met on December 22 in Angola and decided to adhere to their production quota over the next few months. This was against the backdrop of a huge stockpile, which is taking time to get exhausted. Although the American investment banker Goldman Sachs and the International Energy Agency (IEA) chief Nobuo Tanaka perceive an uptick in crude demand in 2010, Opec, in its latest oil market report underscored a more balanced outlook, driven by concerns that surplus oil will weigh considerably on price, at least during the first half of the coming year. The report says,

A more detailed look at the supply/demand balance indicates that fundamentals will continue to be weak in the first half of the year before improving in the second half, as reflected in the demand for Opec crude.

The decision about Opec quota is usually determined by the Opecs perception about the call on its output of conventional oil. The call is usually considered as an expected demand of Opec output after accounting for non-Opec output, adjustment in stockpiles, and output of natural gas liquids and non-conventional oil.

In its latest oil market report, Opec underscores that it expects increased consumption in the US and growth in the developing world, especially China and India, next year to boost world oil demand to an average of around 85.1 million bpd. However, this projection lies well below the 86.3 million bpd predicted by IEA in its latest revised forecast.

Non-Opec supply is perceived as rising by around 3,10,000 bpd next year with the lions share of the increase coming from Russia and other countries from the former Soviet Union. Moreover, supplies of Opec natural gas liquids and non-conventional oils which are not subject to the producer groups output quotas are expected to average around 5.26 million bpd next year, an increase of more than 9,00,000 bpd since last year.

However, what Opec actually ends up producing and its implication for world oil prices depends largely on the compliance of Opec as a whole with the decided quota. Interestingly, Opecs latest oil market report indicates that Opec has actually been grappling with maintaining compliance with output curbs during the current year. According to a recent calculation by Reuters, compliance with the 4.2 million bpd of output cut, which was agreed upon at the acme of the financial crisis last year, has fallen progressively to a mere 58% from a peak of 81% in March and April, resulting in considerable surplus. Thus, the outlook for the next few months would largely depend on whether Opec as a whole achieves success in clamping down on overproduction by its members, in consonance with the commitment expressed by Opec members in the communiqu at the recently concluded meeting.

In this context it is also essential to throw some light on the game plan in the Middle East, a picture that would remain incomplete without duly recognising Iraqs recent endeavours to catapult itself into the big league of oil producers. This notably includes the signing of a 20-year development contract last month between British Petroleum and Chinas CNPC for Rumaila in Iraq, which is one of the worlds biggest oilfields, sparking optimism over large increases in Iraqs crude output. However, concerns have been raised that the geopolitical power balance in the Middle East may face upheaval if Iraq succeeds in increasing its oil output substantially, as Shiite power Iran will feel more threatened than rival Sunni oil giant Saudi Arabia. In fact, Iran, a predominantly Shiite state, and Iraq, now a Shiite-ruled state, also have a long history of border feuds, including one that escalated into the eight-year war in the 1980s. The relationship between the two countries improved after the ouster of Sunni Arab Saddam Hussein in 2003. However, the border tension raised its ugly head once again on the disputed location of an oil well, which Iran claims is located in its territory whereas the Iraqis claim otherwise.

Although the tension appears to have been temporarily resolved, developments in the next few months are going to show the way forward.

2010 is being viewed as a bridging year between the recession and a full-throated recovery. However, the uncertainty surrounding the eventual strength and magnitude of economic recovery and the responsiveness of oil demand following a global recessioncoupled with heightened concern for climate changehas led to a pervasive divergence of views.

If one adds to this the concerns about bearish fundamentals, geopolitical tensions between Iran and Iraq, the nature of Opecs compliance, and risks from factors like rising equity prices and depreciation of the dollar, then most of the predictions about oil prices actually go into a tailspin. The general undercurrent about oil demand and prices is, however, positive. First, there is the IMFs optimistic prognosis of economic recovery, in its latest World Economic Outlook. Second, there is the fact that Chinas oil demand rose 18.7% in November 2009, as compared to a year earlier. This was the fastest rate of growth on record.

The author is a senior fellow at the Asian Institute of Transport Development, New Delhi