It May Be A Cold Winter For Oil Prices

When the opening bell rang at the New York Mercantile Exchange on Monday, Nov. 29, oil traders were prepared for the worst: Four days earlier, in the face of weak demand, OPEC had failed to agree on production cuts. The worst was what the traders got. At the end of a day of frantic trading, the January crude-oil contract had plunged by 7%, to $15.31, its lowest level in almost four years. In the next two days, it recovered only slightly.

Few expect a quick turnaround. Oil prices are heading south with a vengeance this winter. Per-barrel prices have been swinging between $15 and $22 since 1987, but this time traders worry that the hibernation in prices may be long. "There's nothing to suggest we've seen the lows," says Lawrence Goldstein of New York-based Petroleum Industry Research Associates Inc.

DROPOUTS. Consumers benfit from the decline. And Big Oil isn't likely to be hurt much by the plunge, either. That's because most major companies are net buyers of oil, so lower prices initially boost profits. For small independents, though, it's another story. "If oil stays at $15, lots of independents are going to drop by the wayside," says Bruce Anderson, head of Houston-based Bruce Anderson Oil & Gas Properties.

Why can't OPEC get prices back on an upward swing? The main reason: anemic economies worldwide. So far this year, says the Paris-based International Energy Agency, world oil demand is down 0.3% from 1992 and shows no sign of a pickup. U.S. demand is still relatively strong. But demand is down in oil-dependent Japan, and recession-wracked Europe isn't doing any better. Laments Franco Bernabe, CEO of Italy's state-owned energy giant, ENI: "This is the first time in 20 years I haven't seen any growth. It's abysmal." The outlook for next year: "It could get worse," says Vahan Zanoyan, senior director of consultants Petroleum Finance Co.

Nearly as vexing for OPEC is expanding production by nonmember countries, such as Norway, Britain, and Mexico. OPEC continues to gain market share for now (chart). But since the cartel agreed last September to fix its output ceiling at 24.52 million barrels a day to help firm prices, non-OPEC producers have compounded the downward price pressure by turning on their taps.

Take the North Sea. Norwegian and British wells are pumping at record levels, up 25% since 1990. Alaskan production is up 10% since July, thanks to new wells coming on. And new entries in the world oil patch such as Yemen, Colombia, and Syria are all hoping to eat into OPEC's share of the pie. In 1992 and 1993, notes Pierre Terzian of Paris-based Petrostrategies, non-OPEC producers added 700,000 barrels a day of new supplies--while OPEC managed only 400,000. Next year, he predicts, OPEC might not be able to add any new exports at all.

Longer term, Iraq--until the gulf war, the cartel's No.2 producer--could add to the oversupply. On Nov. 26, Baghdad announced it will accept long-term monitoring of its weapons sites by U.N. inspectors, increasing pressure on the U.N. to lift sanctions against Iraqi oil sales. Under discussion: a one-time sale of $1 billion or more in Iraqi oil.

SLASHED BUDGETS. Pressure on OPEC is building. In theory, the cartel can ride out a price slump. That's because it generally costs more to extract oil in places such as the Gulf of Mexico and the North Sea than it does in the deserts of Arabia or North Africa.

But U.S. and European oil companies have been closing the gap. They've cut costs dramatically. And new technological advances, such as 3-D seismic modeling of geological formations and new deep-sea drilling techniques, are allowing companies to slash their exploration and production budgets while opening up once forbidding virgin territory. At offshore wells in the North Sea, production costs are now less than $10 a barrel vs. about $15 a barrel 10 years ago.

Of course, if prices continue to slide, OPEC could yet bite the bullet and clamp down on production. That has Chevron Corp. economist Tom Burns predicting that prices will bounce back to an average of around $19 next year, the same as for most of this year. "Every time OPEC has faced a cyclical low, it has responded by patching over its differences," he says.

Most likely, however, OPEC will wait for economic recovery to light a fire under demand. "There's an old Arab saying that if you're stupid enough to get on top of the tiger, you might as well ride it for a while," says Petroleum Finance's Zanoyan. "It's too early for OPEC to react." Given the many downward forces on oil prices, OPEC's ride may be just beginning.

Before it's here, it's on the Bloomberg Terminal.