Zia Mian, Contributor
THE MAY 29, 2004 'terrorists' attack on foreign oil workers at a housing complex in Al-Khobar in oil rich Eastern Province of Saudi Arabia left 22 dead and many wounded. Such terrorists' attacks on oil related facilities are becoming more and more prevalent. They are intended to put economic and political pressures on the occupying forces and their supporters in the Middle East. No wonder the oil consumers in the world are paying, at a minimum, US$ 5 per barrel premium for a war they never supported.
In response to oil supply security concerns triggered by this new terrorists' attack on Tuesday June 1, 2004, the price of the U.S. Bench Mark crude oil (West Texas Intermediate WTI) climbed to a record high of US$ 42.45 per barrel. On June 3, 2004 in Beirut (Lebanon) the OPEC oil ministers' agreed to raise the formal production quotas by an additional two million barrels per day. The readers may recall that the second quarter quotas were originally agreed at 23.5 million barrels per day on March 31, 2004. The new agreement, yet to be ratified, promises to raise the production quotas to 25.5 million barrels per day.
PRODUCTION QUOTAS
The oil ministers also promised that if deemed necessary, they would add an additional half a million barrels per day to the formal production quotas on August 1, 2004. This action would raise the third quarter production quotas for the ten OPEC members (excluding Iraq) by 2.5 million barrels per day to 26 million barrels per day. The question is, would the decision to raise production quotas help ease the oil price volatility that the consumers throughout the world continue to face? Most oil analysts, me included, believe that OPEC's decision to raise output will have little impact on the oil prices volatility or prevailing war premium. The fact is that current prices do not have much to do with the supply.
LITTLE IMPACT
I believe that the pronouncement by the OPEC oil ministers to raise production quotas will do little to cool the current upsurge in oil prices. The price of WTI is still around US$40 per barrel. The European Bench Mark crude oil, North Sea Brent, is trading around US$37 per barrel. The OPEC Bench Mark Crude Basket is also estimated around US$36 per barrel, about US$8 per barrel higher than the desired upper limit of oil price range of US$22 to US$28 per barrel that is normally used by the OPEC members to trigger production increases.
In the previous article (see Sunday Gleaner May 23, 2004) I argued that the current price volatility has nothing to do with the crude oil supply situation or OPEC actions. There are adequate oil supplies in the world. The analysis narrowed the causes of price volatility to seven non-supply factors that are unlikely to disappear in the near future. Nothing has changed to alter this view. The OPEC members were already producing above their agreed production quotas. For example in April 2004 the actual production from the ten OPEC members (excluding Iraq which does not have a production quota but pumps out about 2.5 million barrels per day of crude oil into the world market) was 2.2 million barrels per day higher than the sanctioned production quota of 23.5 million barrels per day. All the new production quotas would do is to formalise the non-official higher than agreed production levels without adding significant supplies to the market. Let us accept the reality that the rhetoric of begging by the consuming nations for increases in the supplies of oil is not going to solve the problem of price volatility. Even if the physical supplies were raised, the strained refining utilisation factors in the U.S. would make it impossible to process added supplies to meet the upcoming summer gasoline demand. The Energy Information Agency's latest estimates indicate that the U.S. refineries are currently operating at around 95 per cent of their rated capacity (Weekly Petroleum Status Report, Week ending May 28, 2004). An increase in the crude oil supplies could not and would not increase the processing capacity and thereby the supply of gasoline in the U.S. market. Nevertheless, concerns with regard to the gasoline shortage would remain.
MIDDLE EAST INSTABILITY
The issue therefore is, not that an increase in crude oil supplies would bring an end to the current situation. The OPEC or other suppliers are not determining the current oil prices. Professor Robert Mabro of Oxford Energy Seminar, in his commentary (see Middle East Economic Survey May 31, 2004) argues that "The reference prices for oil in international trade are determined in New York and London in the futures exchanges for WTI and Brent respectively. Any attempt to understand why oil prices have moved in one direction or another, or why they are high or low must take its starting point in the futures market. Those who trade on futures markets are moved by a host of factors that include expectations about future developments in supply and demand. Some traders have longer time horizons than others. Those who look, say, six months or longer ahead, worry today about the following factors."
ECONOMIC CONCERNS
The security of supplies and stability of energy prices are major economic concerns that impact the development sustainability in most of the developing countries. Sustained oil price pressures continue to threaten this already abject sustainability. The major factors that impact today's prices (particularly the war premium) are imbedded in the Middle East security concerns. Notwithstanding the rhetoric, Saudi Arabia is faced with serious threats to its monarchy. Any chaos in Saudi Arabia could immediately cut-off nine million barrels per day of supplies from the largest OPEC oil producer, thus removing about 11 per cent from the world oil supply stream. Will the Bush Administration be willing to commit additional forces in the Middle East to ensure the security of Saudi supplies? What would it cost the taxpayers to re-deploy the forces in Saudi Arabia?
Added to this is the continued unstable situation in Iraq (military, social, religious, political and economic). These two are the paramount security concerns that guide the psychology of traders and speculators. The futures prices represent the current market opinion of what the commodity will be worth at some time in future. The traders and speculators are worried that the situation in the Middle East is not getting any better and are therefore pricing the futures market for petroleum accordingly. The trends in Brent price in London's International Petroleum Exchange (IPE) and the WTI price in New York Mercantile Exchange (NYMEX) reflect these psychological factors. They in turn impact the physical prices and ultimately determine what you and I pay at the pump.
IMPORT BILL
Based on the data from the Economic and Social Survey Jamaica 2003, I estimated the income elasticity of demand for oil at 2.9 per cent, which is considered very high. If one believes the GDP numbers indicated in the survey, then Jamaica must prepare for unprecedented increases in its oil import bill. The NIR would not be able to finance this import bill and also underwrite the continued economic stability. It is noteworthy that the Economic and Social Survey Jamaica 2003 was amiss at presenting the GDP estimates for 2003 at current prices (see: Chapter three Gross Domestic Product). The estimates included are only in constant prices, and show a real GDP growth of 1.4 per cent over the previous year. Can somebody explain how these estimates were arrived at and why the data in current prices was omitted from the survey?
On another note, this week, the OUR approved a non-fuel rate increase for the Jamaica Public Service Company (JPSCo). The views that the consumers would bear a minimum impact of this price increase have to be analysed within the framework of the fuel cost increases for JPSCo (a direct pass through) that were more than 50 per cent last year, the efficiency of the JPSCo system and the continued high system losses). As the essentials of the volatility of oil prices and its supply and demand would not materially change in the short to medium-term, in the forthcoming articles we would address some of the issues that would impact Jamaican consumers owing to a continued volatility in the world oil prices.
Zia Mian, a retired senior World Bank official, is an international consultant on information technology and energy. He writes on issues of national, regional and international interest. Views expressed in this column are those of the author and do not reflect those of the Government. Send your comments to mian_zia@hotmail.com.
