Over a barrel
International oil markets are reflecting the general uncertainty over the course of the war in Iraq, write Walid Khadduri and Gerald Butt
Markets have been dancing to their own tune in recent days, paying no mind to the pressures of supply and demand. In the world of oil, the present Iraqi crisis has shown that prices are now completely divorced from market fundamentals. Rather, they are subject to the influence of news headlines, politics, psychology and perceptions -- not to mention rapid profit-taking by institutional investors.
During the first days of the war, with optimistic assessments of progress coming out of Washington and London, oil prices dropped by around $10/barrel. This slide occurred even before the US Department of Energy and the International Energy Agency -- the industrialised countries' watchdogs -- announced they would tap their strategic reserves to compensate for any shortfall in Iraqi oil supplies. However, as it gradually became clear that the Iraqi army was putting up stiff resistance, prices jumped by more than $1.50/barrel in a single day.
Neither the price increase just before the war, nor the subsequent fall at the outbreak of hostilities related to the volume of oil available in the market. Today's oil markets, like those of other commodities, are strongly impacted by a headline or urgent news flash. Indeed, circumstances have changed considerably from the 1970s when prices were determined by the Organisation of Petroleum Exporting Countries (OPEC). Today, the markets in New York and London, with their many instruments of spot, future, forward and hedge sales, are an important factor in creating conditions leading to price volatility.
Nonetheless, fundamentals continue to be strong players on the scene and make their presence felt on both prices and market developments.
Take for example the role OPEC has played in the past three months. Oil producing countries have taken it upon themselves to balance supply and demand, whenever possible, in order to achieve a price range of $22-28/ barrel for the OPEC basket price (a price band of $22- 28/barrel). This goal has never been more difficult and challenging than in the past quarter.
The quarter began with the sudden general strike in Venezuela that paralysed the country for several weeks and caused much civil strife. The country's oil production declined from around three million barrels/day (b/d) in late November to as low as 150,000 b/d in mid- December. It has since gradually risen to around two million b/d, but it is doubtful that it will return to its pre-strike level any time soon because of the firing of some 12,000 employees in the national oil company, and the closure of some difficult fields. Restarting production from these will not be easy owing to technical reasons. OPEC consequently had to move quickly to replace the shortfall in Venezuelan exports; and while it took some time to deliver oil from the Gulf to US markets, there were never actual shortages that hurt consumers.
Meanwhile, the threat of a war on Iraq had been looming on the horizon from as early as the latter part of 2002. However, initially, this was not of major concern to international oil markets. The loss of Iraqi oil had become a common phenomenon because of frequent disputes between Iraqi authorities and the United Nations (UN). Accordingly, markets had become accustomed to the absence or shortfall of Iraqi oil exports in recent years and were able to substitute supplies from other sources.
But this time the situation was different. While it was known that Iraqi oil production and exports would cease with the beginning of the war, just how long this absence would last was anyone's guess. There were rumours -- subsequently proven false -- that the Iraqi regime would mine the country's oil fields. Even so, there was fear that armed conflict would cause serious damage to oil installations, and that it might take several months to secure production sites and organise the return of industry employees once peace was restored. With these concerns in mind, OPEC member states, during the past three months, began increasing production over and above their allotted quotas in order to prepare for shortfall to Iraqi exports.
However, a new and unexpected factor surfaced during the past quarter: the partial shutdown of Nigerian oil exports. First there was an industrial dispute between unions and management, leading to a strike by oil workers. But the most serious development was the tribal and social upheaval in the Niger Delta in late March causing a shortfall of around 800,000 b/d of crude oil -- approximately 40 per cent of the country's production. The situation is expected to worsen in the next few weeks with the general and presidential elections in the first half of April. As was the case with the Venezuelan experience, OPEC was taken by surprise.
Also impacting market developments in recent weeks was the phenomenal rise in natural gas prices in the US, prompting consumers to revert to fuel oil; there was also the closure of nuclear power plants in Japan, and the low level of commercial oil stocks held by American firms. These three factors exacerbated pressure on prices, causing them to rise to as high as $35/barrel.
It is to OPEC's credit that with 11 September very much in the background and hundreds of journalists in the Gulf covering the war, there have been very few attacks on the organisation accusing it of exploiting the problems in Venezuela, Iraq and Nigeria to increase prices or create artificial shortages. The contrary is true. The heads of the International Energy Agency and the US Secretary of Energy have both gone out of their way to issue public statements to the effect that producers have been very cooperative in stabilising markets during very difficult periods.
Where all this will lead remains to be seen. OPEC, and its Arab member states in particular, have faced continual criticism and pressure over the past few decades, constantly being accused of artificially increasing prices. Moreover, Western media and analysts have never missed an opportunity to point out that the Gulf is an insecure source of supply and that the West should find new sources of oil and alternative sources of energy. OPEC has been saying for years that its aim is to stabilise supply and demand at prices agreeable to both consumers and producers.
OPEC, it seems, hopes the present experience will convince sceptics of its policies and goals. At this time of uncertainty in Iraq neither OPEC nor governments around the world can do anything other than respond to oil market volatility and other developments on a day-to- day basis.
Walid Khadduri and Gerald Butt are editor-in-chief and Gulf editor, respectively, of Middle East Economic Survey (MEES).
