There is little sign that high oil prices will ease for the remainder of this year or in 2006 unless both upstream and downstream capacity constraints ease, global economic growth slows dramatically, or tensions in oil-producing countries ease, according to the August Monthly Oil Report of the Center for Global Energy Studies (CGES). “Continuing oil demand growth has led to tightness throughout the oil supply chain and created an environment in which the desire to hold higher stocks and fears of a supply disruption are driving oil prices,” the report said. But it added that high oil prices had begun to have an impact on the global economy and oil consumption, with inflation rates starting to rise in industrialized economies, while developing-country governments struggled to maintain subsidized product prices.

The report said that despite oil demand growth in 2005 expected at half that of 2004, the need for low-sulfur products – especially diesel – was testing refinery capacity. According to CGES, if refiners are to meet peak demand, they will need to build up product stocks in advance, requiring higher utilization rates during traditionally slack periods in the absence of much new processing capacity: “Unless the growth in demand for low-sulfur diesel is curtailed, we may begin to see a change in the traditional seasonal pattern of refinery utilization. New refining capacity will not be added in sufficient quantity to ease this pressure next year unless there is a dramatic slowdown in demand growth, which means that prices will rise to a level that balances demand with constrained supply.”

On the supply side, poor non-OPEC oil production growth in 2005 of just 400,000 b/d has boosted the call on OPEC by 1.3mn b/d compared with last year, the report said. While some of this will come from increased output of NGLs and condensates, the need for OPEC crude is expected to be 1mn b/d higher in 2005 than it was in 2004. “Most OPEC members are already producing at capacity, leaving little spare to cope with any of the potential supply disruptions that are haunting the market,” CGES said, listing fears of terrorist attacks in Saudi Arabia in the wake of King Fahd’s death, heightened tension between the US and Iran over the latter’s nuclear program, ongoing attacks on Iraq’s oil infrastructure, continuing unrest in parts of the Niger delta and Venezuela’s claims for back taxes against foreign companies operating in the country as factors bolstering prices. The report said these fears were unlikely to subside quickly and only greater spare production capacity to offset any disruption would lessen their impact on prices. Amid OPEC capacity expansion, Saudi Arabia should boost its capacity to 11.3mn b/d by the end of 2006, but non-OPEC output growth is faltering. “If the industry’s upstream projects all go to plan next year, non-OPEC output could rise by as much as 1.2mn b/d, easing some of the pressure on prices, but it would be a rare year indeed with no setbacks to any of the complex projects on which rising non-OPEC output is dependent,” the report said.

Stocks Forward Cover Still Two Days Short

CGES said that despite tight supply, stock levels should increase at a rate of about 1.25mn b/d in 3Q05 and increase counter-seasonally in 4Q05. However, these rising stock levels are still a full two days below desired levels, and as a result prices should continue to climb, with Dated Brent averaging over $62/B in 3Q05 and nearly $66/B in 4Q05, the report forecast. It added that forward prices indicated the market was anticipating global oil demand growth in 2006 of around 1.8mn b/d but was taking a much more pessimistic view of non-OPEC supply growth at just 600,000 b/d in 2006. “These assumptions create the conditions for a very tight market over the coming winter, Dated Brent averaging of $72/B in 1Q06 and remaining above $60/B for the remainder of the year – even with OPEC production continuing at 30.5mn b/d,” CGES said, warning that a recovery of demand in 2006 could see even higher prices.

CGES said it expected high prices to contribute to a further weakening of oil demand growth, which we see at about 1.6%, or 1.4mn b/d in 2006. On the supply side, new deepwater projects should help to boost non-OPEC output, but start-up delays and continued decline in OECD production were expected to limit next year’s increase to around 800,000 b/d. “In this case, with the current level of OPEC production maintained through the first half of 2006, stocks would continue to rise and OPEC would need to trim output in the second half of the year to keep oil prices above $50/B, which we believe to be an unofficial target price,” it said.