Washington Report on Middle East Affairs, September 1998, page 79

Trade and Finance

Nine-Month Oil Price Slump Problematic for Producers

By Colin MacKinnon

The price of oil is down—really down. Example: Brent Blend, a benchmark crude which averaged $19.30 a barrel in 1997, sold for just over $14 a barrel in the first half of 1998. By the end of July—this after a run of meetings of oil ministers during the spring and summer—Brent was selling well under $13 a barrel.

Arab Light, a high quality Saudi crude, which had been averaging over $12 early in 1998, plunged to $8.52 a barrel on June 15, far below the general OPEC target price of $17 to $18. The June price marked the lowest Arab Light had been since 1986, an annus horribilis for producers. At the beginning of July the average price for a barrel of OPEC crude was $10.72.

The slump has been going on for nine months and shows no sign of reversing direction. It will have severe consequences for Middle East countries, many of them threatened with revenue cuts of up to 40 percent.

Take Saudi Arabia. Oil revenues account for 75 percent of the Kingdom’s budget. As a result of the downturn in prices, the Saudi government is experiencing a major cash flow problem this year. Inevitably, the Kingdom’s budget deficit is increasing: targeted at $4.8 billion, the 1998 deficit could easily balloon to $10 billion. Payments arrearages to contractors, both foreign and domestic, are growing.

Kuwait has planned its 1998 budget, including a large deficit, on a projected $12 barrel. But with prices around $10 and likely to stay there, Kuwait may have to redraft its spending and investment plans.

Oman has recently released statistics showing that the country’s Gross Domestic Product declined 11 percent in the first quarter of 1998 thanks to a fall-off of oil revenues.

Poorer and less stable major exporters, like Algeria and Iran, will feel even greater heat.

It’s not just petroleum-producing countries that are suffering, however. In the Middle East, in particular, non-producers also will be hurt. Regional trade and investment will decline and remittances from expatriate workers—the Jordanians, Egyptians, Tunisians, Sudanese, and Pakistanis who work in the producing countries—will fall off.

How come? Why the slump now?

There are three reasons. One of them is El Niño, the warming of central Pacific Ocean currents that periodically disrupts the world’s weather systems. El Niño brought an unusually mild winter to North America and Europe in 1997-98 and is partially responsible for the buildup of record fuel inventories in consuming countries, an oversupply that will take a long time to reduce. Summertime U.S. stocks of distillate fuels, for example, are at their highest levels since the Gulf war. The effects of El Niño may last through 1999.

New Iraqi Oil on the Market

The other two problems are new Iraqi oil sales and the Asian slump.

On June 1, Iraq began exporting petroleum under a revised U.N. “oil-for-necessities” plan that allows Baghdad to sell up to $5.250 billion worth of oil over a six-month period, up from the $2 billion previously allowed. Iraq says it plans to export $4.5 billion worth of oil over the June-December period.

Nobody knows how much oil Iraq can actually pump and export. To gross $4.5 billion at, say, $10 a barrel, Iraq would have to export 2.5 million barrels daily. This isn’t likely. It was only in May, in fact, that Iraq was able to pump more than 2 million barrels a day. Though the U.N. reports that Iraq averaged 2.4 million barrels a day in exports during the last two weeks of June, this was probably a fluke.

Still, Iraq is scheduled to export 1.78 million barrels a day in August, a little less than July’s 1.9 million, but well over the 1.6 million barrels a day the industry has thought Iraq capable of exporting. Whatever Iraq’s new average production turns out to be, it is a wild card that is forcing markets down.

OPEC’s ability to deal with Iraqi production is not impressive. When Baghdad began selling oil overseas again in 1997, OPEC, though it knew a shock was coming, was caught flat-footed and was unable to apportion cuts among members to take up the slack. Accordingly, prices fell 24 percent in the first two quarters of that year. Something similar is happening now.

Finally, there’s the Asian economic debacle, which began last July when unforgiving financial markets hammered at Thailand’s economy and currency. Thailand’s crash caused investors to begin looking at their investments in other countries such as Indonesia and South Korea which, like Thailand, had poorly regulated financial sectors, overvalued currencies, and high current account deficits. By now, the recession has spread throughout Asia and around the world, affecting countries as diverse and far-flung as Russia, Mexico, Canada and South Africa.

But it was Asia—developing, growing Asia—that had star billing in oil producers’ eyes. Ten Asian countries—excluding Japan—accounted for 40 percent of increased global oil demand between 1986 and 1996. Between 1992 and 1996, they accounted for two-thirds of the increase.

Such growth is over for a while; Asian demand is falling. The International Energy Agency has revised its estimates of annual regional demand in Asia downward by 700,000 barrels a day, from 20.6 million to 19.9 million.

Oil producers may well be forced into another round of production cuts, though so far this year they’ve already pledged reductions totaling 3 million barrels a day. As usual with OPEC, there has been a certain distance between the promised and the actual. By May, for example, OPEC members had cut production by just over 500,000 barrels a day, having pledged cuts of 1,245,000 barrels a day.

Look for OPEC oil ministers to hold an emergency meeting in October.

Unprecedented Agreements

Venezuela and non-OPEC producer Mexico and have met twice this year with Saudi oil officials in Riyadh and Amsterdam, just before OPEC ministerial meetings, to make separate side agreements to cut production.

These agreements, which were unprecedented and which surprised industry observers, may presage a new alignment of producing countries. In June, Saudi Arabia floated the idea of involving Mexico, Russia and some other countries, perhaps Norway, in a less formal arrangement, separate from OPEC, that would act to hold world petroleum prices within a certain range, say $18 to $21 a barrel for Brent Blend. Countries likely to form the new grouping would have large reserves and high production capacity and would be dependent on oil revenues.

Significantly, both Mexico and Russia sent observers to the June OPEC meeting in Vienna.