Crude oil gas prices

Oil markets in 2001 behaved like the proverbial month of March, coming "in like a lion and going out like a lamb." The year began with a nasty energy crisis rapidly descending upon many parts of the globe. By year-end, this "crisis" had faded so fast that some suspected it was simply concocted. As 2002 begins, a lingering question is whether oil markets are now so saturated that the industry is exposed to a glut once again, or could the market be so closely in balance that either strong OPEC compliance or an increase in demand re-creates the alarming tightness of a year ago?

At the start of 2001, oil prices averaged around $3/bbl (WTI). Had the U.S. not released 30 MMbbl of SPR crude in the fall of 2000, the price would likely have been even higher. Over the course of the ensuing year, oil prices then fell by over 40%.

Was this extreme tightness and resulting high prices an aberration? Is the oil industry now going to return to the more "normal" prices that consumers enjoyed for so long? How bad was the drop in oil demand? When might demand recover? Can OPEC comply with its major cuts? Were they ever real? What roles will Russia and Iraq play? These are the key issues which will shape oil markets throughout 2002, as discussed here.

WEAK DEMAND DOMINATES 2001 OIL MARKETS

Oil prices started coming under pressure last spring, as signs of a slowing economy and a concurrent slowdown in oil demand began to dominate oil news. Weekly reports of rising U.S. oil stocks added to the bearish tone of the oil markets. A growing group of oil observers were certain prices would soon collapse, although prices actually stayed surprisingly strong until the September 11 events.

These demand fears grew as the year progressed, despite several upward revisions to demand data, often significantly narrowing any gaps in year-over-year demand. Any time a weekly report on U.S. oil stocks showed any growth, oil speculators were spooked into increasing their short holdings of NYMEX crude contracts. Little attention was paid to the fact that record levels of U.S. finished-petroleum-product imports were leaving Europe's petroleum stocks at their lowest levels in years.

Worries of a renewed global oil glut also grew. By the end of 2001, the International Energy Agency's (IEA) supply/demand estimates for seven quarters ending September 30, 2001 showed a supply excess of 560 MMbbl of oil, although reported Organization for Economic Cooperation and Development (OECD) stock builds accounted for only 175 MMbbl--the "missing barrels" were back once more.

For a day or two following September 11, oil prices jumped by several dollars a barrel on worries of possible supply disruptions. But, as NYMEX crude trading re-opened, prices collapsed--soon, the $20 floor was breached.

Oil demand concerns were justified in the first few weeks following the terrorist attacks, particularly in the hard-hit jet fuel market. U.S. petroleum demand in September 2001 was down over 800,000 bpd, or 4.3% compared to a year ago. However, it made a surprising rebound over the rest of 2001. This was either ignored or dismissed as faulty data by most oil observers, who remained extremely gloomy on both oil demand and the U.S. economy.

Compounding these worries, winter weather through Christmas was abnormally mild. Even a burst of arctic weather in the last week of 2001 barely made a dent on heating demand. At the end of 2001, the U.S. winter measured by heating-degree days was 19% milder than normal and 26% warmer than a year earlier.

Despite all of this apparent bad news on demand, preliminary numbers for U.S. oil consumption in 2001 show that the year was equal to 2000's all-time record high, Table 1. The table details estimated U.S. petroleum demand for 2001, compared with the two previous years. In total, U.S. petroleum demand changed relatively little over this period, while the economy initially soared and then weakened. All three years saw new, all-time demand records set for various key petroleum products, while other petroleum products suffered demand declines, even when the economy still boomed.

OPEC'S PRODUCTION CUTS

OPEC announced four production cutbacks during 2001. A cut of 1.5 MMbpd was announced in mid-January. Second and third cuts of 1.0 MMbpd each came in March and July. While the market was highly skeptical of OPEC's compliance, oil prices stayed in a tight $26 to $31 range until after the September 11 terrorist attacks, when prices plunged, hitting a low of $17.50 in mid November. OPEC responded with its fourth announced cut of 1.5 MMbpd to begin in January 2002. After some intense arm-twisting, various key non-OPEC producers also agreed to cut their production by about 460,000 bpd.

The extent to which OPEC complied with its first three cuts is still widely debated. Oil speculators have aggressively bet that OPEC's compliance has been weak, and many doubt the latest cuts will see better compliance.

Data confirming OPEC's total production and its exports is "fuzzy" at best. While half a dozen organizations constantly report estimated OPEC production figures, the variances between each of these estimates is often startlingly large and even more disparate when the production estimates of each OPEC country are analyzed.

The most accurate OPEC data, although dated and incomplete, are OECD's reports on its country-by-country OPEC imports. This data, which covers about 80% of OPEC's total exports, rarely conforms with the far-higher production and export swings most published estimates show. The import variances by each month can also be very high or quite low, but often a low monthly import is subsequently followed by far-higher levels and vice versa. This makes it dangerous to read too much into a single month's data.

The latest data to the OECD on OPEC exports for 12 months ending July 2001 fails to confirm that OPEC ever produced, or at least exported as much oil as most estimates have reported, nor does it confirm close compliance to the magnitude of announced OPEC cuts through July. The numbers do highlight that Iraq still remains the biggest swing exporter.

This lack of reliable OPEC data underscores the poor overall quality of oil data, particularly in light of how sensitive small changes in published oil data can be in impacting the price of oil.

The degree of OPEC compliance with the latest cuts will have a material impact on 2002 oil markets. If compliance is high, oil demand could weaken even further and still leave oil supplies in a tight state. Conversely, if oil demand picks up, these cuts could end up being too severe, setting the stage for OPEC production increases to keep the market from getting too tight.

RECORD SHORTS FOR NYMEX CONTRACTS

Speculators ("non-commercials") in NYMEX crude oil contracts stayed in a net short position for most of 2001. The accompanying figure illustrates the steady growth in net short crude holdings by non-commercials or speculators in crude contracts from the middle of 2000 through the end of 2001. At year-end, speculative shorts for crude oil were at an all-time high, running almost 7:1 over speculative longs. These speculators were only in net long positions for 14 weeks of 2001. Curiously, the few times that speculators' holdings of NYMEX crude contracts changed from being net short to net long, the price of crude always rebounded by large margins.

This pattern proves once more that speculators' behavior in the NYMEX crude markets is the best leading indicator of what oil prices do over a near-term period. And these record levels of speculative shorts demonstrate that many oil observers still believe that oil prices will stay low or even continue to fall.

ARE FUNDAMENTALS REALLY BAD?

As 2002 begins, it is important to try to assess whether the bearish oil sentiment still overhanging the global oil markets is justified or now overblown? Key to answering this question is what happens to 2002 oil demand in the U.S. and the rest of the world. This answer will partially depend on how the global economies perform, although the impact of GDP changes is less profound to oil demand than most economists assume.

Weather and population demographics still have major impacts on demand. Thus, watching winter weather in both the U.S., Europe and Northern Asia in the critical months of January through March could have a far greater impact on global oil demand than economic performance around the world.

Future oil supply will also have a major impact on 2002 oil markets. The degree of OPEC compliance to its new cuts, how long these cuts stay in place, what Iraq does, whether Russian production gains are sustainable and whether Russia complies with its announced cuts, and how the rest of nonOPEC supplies respond to the lower oil price environment are the key supply factors to watch in 2002.