Got Those Opec Blues Again

Oil prices are up, so is demand, and producers are standing firm

Many experts were skeptical last March when OPEC members pledged to cut back the supply of crude and push oil prices higher. Sure, OPEC can keep the troops in line for a little while, the reasoning went. But once the price tops $20 per barrel, the ranks will crumble and the oil will flow again. Back then the price of West Texas Intermediate was around $13 a barrel.

On Nov. 23, with OPEC still standing firm and Iraq threatening to withhold the 2.2 million barrels a day it is currently allowed, a barrel was selling for almost $27, the highest price since the 1991 gulf war. OPEC members have been unusually disciplined, but they can't take all the credit for the rise in oil prices: With the biggest consuming economy, the U.S., expanding at a 4% annual clip, growth strengthening in Europe, and recovery taking hold in many parts of Asia, demand for oil is outpacing supply. If these conditions persist, some forecasters predict, prices could hit $35 next year. "This is territory most people don't remember," says Leo P. Drollas, deputy director of the Center for Global Energy Studies in London.

That's because for most of the past two decades there has usually been more than enough supply to meet demand. This quarter, however, the world has been consuming 2.8 million more barrels a day than are being produced. And the gap will widen by an additional 1 million barrels a day in the first quarter of next year, figures David H. Knapp of the International Energy Agency in Paris. "The world needs more OPEC oil, and it needs it soon," Knapp says.

SUPPLY SQUEEZE. Making matters worse, overall thirst for oil is expected to grow by 1.7 million barrels per day next year, compared with 1.1 million barrels per day this year and just 400 million barrels per day in 1998. The biggest increase is likely to come in Asia, which is expected to show growth in excess of 4% per annum through 2003, according to Deutsche Bank. So far oil consumption in India alone, the largest petroleum importer outside the 29-member-nation Organization for Economic Cooperation & Development, is growing 8% annually.

In fact, Asia is pulling so much oil from the Middle East that with the high demands of the winter heating season, the European and North American markets find themselves squeezed for supply and facing scary prices. Predictably, the recent domestic spike in prices has prompted the usual Congressional calls for tapping the Strategic Petroleum Reserves to relieve the pressure on supply.

OPEC remains unmoved by calls for higher production. Members fear that any easing could trigger yet another price collapse, recalling bitterly the disastrous consequences when they increased quotas at a November, 1997, meeting in Jakarta. Not long after, the Asian and emerging-market economies collapsed, the world economy slowed, and oil inventories ballooned. That led to sharply falling prices. OPEC eventually managed to trim its oil output from 28 million barrels a day last February, to just under 24 million today, excluding Iraq's.

Not surprisingly, Iraq's Saddam Hussein could end up as the wild card as far as supply goes. Currently, he is threatening to shut down Iraq's exports of more than 2 million barrels per day in protest over the U.N.-administered oil-for-food program and the continuing sanctions against Iraqi trade. His boycott is not expected to last more than a few weeks, however. And ultimately, what Hussein really wants is to repair his economy by eventually pumping as much as 6 million barrels daily. To reach that number would take a few years, but the gradual increase in exports could undermine OPEC efforts to keep the lid on.

BIG OIL WINDFALL. There are also serious questions being asked about major non-OPEC producers, such as Mexico, Norway, and Russia. These major exporters have committed to cutting production by 600,000 barrels per day but have not yet done so. And Russia, which might like to cash in on the high prices, would have problems increasing its exports dramatically because of its own production constraints.

Of course, as long as the tight supply situation lasts, it's good news for Big Oil's earnings and share prices, which are rebounding from the doldrums of 1997 and 1998. Analysts figure that major oil companies such as BP Amoco, Chevron, and Royal/Dutch Shell Group will post earnings increases in the 15% range for both 1999 and 2000, mainly because of higher prices. L. Bruce Lanni, an analyst at CIBC World Markets Inc. in New York, figures the best U.S. performers will be Amerada Hess, Chevron, and Texaco because their earnings are most sensitive to crude prices. He expects Exxon Corp.'s earnings this year to fall to $2.30 per share, from $2.61 in 1998, because the company is heavily tied to refining and marketing and low-priced petrochemicals. But he forecasts a rebound in 2000 to $2.85 per share, excluding earnings from Mobil, which is expected to be combined with its Big Oil brother in the near future. "I see clear sailing ahead for the next two to three years [for the industry]," he says.

With higher prices and richer cash flows, companies will also be tempted to invest more in exploration and production. Already, BP Amoco is planning to increase its capital spending from $7 billion this year to $9.5 billion in the next two years. But that's still lower than the $11.5 billion it spent in 1997. "We don't believe these high prices are sustainable," says Marianne S. Kah, chief economist for Conoco Inc., although she does believe that $22 oil may be realistic. The Houston-based company says it will play it conservative, with a very "conservative" increase in its exploration budget next year.

Given their lack of confidence, companies are also likely to continue to consolidate. While oil companies may seem gigantic, the industry is still quite fragmented. Much of world production is in the hands of national companies, and the biggest marketer, Royal Dutch/Shell Group, has less than a 10% share of the world market. But how much more in the way of consolidation and pricing power the world's governments will allow remains to be seen.

Ultimately, however, there's a strong case to be made that producers could enjoy a good next few years without bankrupting consumers. On the plus side for producers: Nobody is talking about spending sprees, and OPEC is only cheating a modest amount on quotas. For consumers, there is some hope that pressure on supply will not spike, since rebounds in Europe and Asia have thus far been extremely measured and the U.S. shows signs of slowing down. Even so, at least for the next year, it doesn't look like the U.S. and others can count on lower oil prices to keep inflation in check.

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