Oil price at comfortable level?

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Something to chew over: The reference basket of 12 crude oils of OPEC stood at 79 dollars on Friday, July 30. This year, the OPEC reference basket has been moving between $70-$80, to average $76/b. OPEC had suspended its official price band in 2005, so the reference basket doesn't reflect the oil price in the market as itself. However, it still gives an idea of the value of OPEC's crude output. So now, why does the OPEC consider the current prices, 'comfortable'? Well, according to Secretary General Abdalla El-Badri, that's because, "The economic recovery is sluggish, unemployment is still high and the debt crisis is causing a lot of uncertainty, so if you look at all these factors, the current price is comfortable."

OPEC is scheduled to meet in Vienna on Oct.14. Said El-Badri ,"I don't see any change in the production and I don't see a meeting coming before October" . When they met last in Vienna on March 17, the cartel kept the production quotas unchanged. Indeed, it was the fifth time since 2008 with unchanged output levels. Then, they had expected the emerging markets to absorb the excess oil and maintain the 'healthy crude prices.' Things haven't changed much since then, at least with that outlook, with the energy giant still looking at the consumers in China and the Middle-East. With good reasons:

Right now, there is:

confusion on the extent of economic recovery

the sovereign debt concerns, uncertainty in future growth prospects and policy responses, slow recovery and weak property market in the US

debt crisis in Europe

sluggish growth in the US

fiscal and monetary tightening in China

uncertainty over the European banks capital buffers

On the Global economy-some indicators

The IMF has raised Global economic growth from 4.2% to 4.6% this year, while the growth for next year has been kept at 4.3 percent. IMF has also predicted the advanced economies to grow by 2.6 percent this year. It estimates the U.S. economy to expand by 3.3 percent this year and Japan's Gross Domestic Product to increase by 2.4 percent in 2011.

For the euro area, the IMF has kept its forecast for 2010 unchanged at 1 percent and reduced its 2011 outlook from 0.2 percentage point to 1.3 percent. China's growth is the fastest at 6.8 percent, from 6.3 percent in April while India's GDP growth pegged at 9.4% this year. The overall growth prospects for the emerging markets kept at 6.8 percent, from 6.3 percent in Apri.l According to EIA, consumption from emerging economies-outside Organization for Economic Cooperation and Development -account for 52 percent of the world's oil use by the year 2015, compared to the 47 percent this year. IMF feels that faster expansion in China, India and Brazil are helping the global recovery.

According to OPEC, the world economy has gained momentum and expected to grow by 3.8% this year. So far the recovery supported by fiscal and monetary stimulus would have to be taken over by private consumption and investment to compensate. OPEC expects the world economy to grow by 3.7% in 2011, due to the fiscal austerity measures in most of the developed world and monetary and fiscal tightening in China.

The indicators, positive so far, now for oil;

Oil Demand:

In a monthly oil report released this month, OPEC has forecast world oil demand to grow by 1m bbl/day to 86.4m bbl/day in 2011. The report further said that the demand growth would be fuelled by non-OCED countries like China, India, Latin America and the Middle-East. "On the product side, demand for industrial fuels will be strong as a result of the ongoing economic recovery. Demand for transportation fuels is also forecast to increase," it added

The world's oil demand growth this month has been kept at 900,000 bbl/day, the same as last month. OPEC predicts that OECD region will not see any growth this year, mainly due to declining demand in Europe. "In 2011, non-OPEC oil supply is expected to grow by 300,000 bbl/day. Brazil, Canada, Azerbaijan, Colombia, and Kazakhstan are forecast to be the main contributors, while Mexico, UK, and Norway are foreseen to experience the largest declines," OPEC said. So, the demand for OPEC crude this year has been pegged at 28.7m bbl/day, which is about 100,000 bbl/day lower than the previous month's estimates. Compared to last year the estimate is lesser by 300,000 bbl/day.

Demand for OPEC crude is expected to be in the range of 28.8m bbl/day, or an increase of 200, 000 bbl/day in 2011. EIA predicts oil demand increasing by 1.3 million barrels a day in 2011. And according to the Paris based agency, China is the world's largest energy consumer, exceeding the US by about 4%, a claim dismissed by China as 'unreliable'. In 2008, the US consumed 19.4 million barrels a day, out of 84.4 million barrels a day total consumption. BofAML (BofA Merrill Lynch Equity Rating System) is predicting the total oil demand in Europe to fall by 273 thousand b/d in 2010.

Clearly, demand is just picking up.

Oil Inventories:

BofA Merrill Lynch Equity Rating System (BofAML) had forecast $88.50 per barrel for the second half of next year. The analysts see 'some downside risks' to the 2011 oil forecasts, according to weekly research data from BofAML. And a worrying factor, according to the bank's analysts, is the high OECD oil inventories.

U.S. stocks of middle distillates had climbed to 3.935 million barrels for the week ending July 16. That is 24% above the 5-year average. For the same week, oil inventories reported a rise of 400,000 barrels according to U.S. Energy Information Administration, even as analysts expected a decline. The stockpiles of distillate, including diesel and heating oil, rose 3.9 million barrels more than the predicted 700,000-barrel increase, while gasoline inventories rise 1.1 million barrels. According to OPEC, non-OPEC supply, due to better production data, was expected to increase by 700, 000 bbl/day in 2010 this year, an increase of a little more than 100,000 bbl/day from the previous month.

So to go back to the 'comfortable levels' alluded to by Mr. El-Badri :

Comfortable for whom and why do they say "comfortable"? Is this a poor translation or a double entendre? Does it mean equilibrium? Obviously OPEC wants it as high as possible, without killing the economy, and demand is slowly improving, so now what?

Maintaining a normal inventory is easier for OPEC. Oil inventory levels could be difficult to maintain, if the demand level keeps falling. 'In this environment, OPEC's best bet to keep control of prices is to normalize stock levels across the oil market,' BofAML analysis maintains.

Together with the production cut and the softer demand, the compliance should be high. Production quotas are usually tweaked around, resting at only 53 % according to the latest figures from OPEC. Which prompted call for better compliance, "There is a lot of oil in the market and we need better adherence to our production quota," El- Badri said.

In terms of that, here it's not exactly demand and supply as most understand, its maximizing return on an ever depleting resource. Which leads to the question of availability of the resource: There is a six month moratorium on offshore drilling in the US in the wake of the oil spill in the Gulf of Mexico. (Though it's still unclear at this point, if the moratorium will stay, as the U.S. District Judge, Martin Feldman has granted a preliminary injunction, barring the enforcement of the moratorium.) According to the U.S. Energy Department, the moratorium will decrease by 70,000 barrels a day from the previously estimated 2011 oil production. "I am sure after the six months that they will at least revisit the decision and try to let things go back to normal," El-Badri said.

Almost in a domino effect, Norway has suspended the issuance of new deepwater offshore permit, while Russia has tightened the rules of deep water drilling. Currently, according to EIA, one-third of the world's oil supply comes from offshore drilling. Of course, there is oil with the current inventory levels, but the moratorium will impact the oil prices in the long term with delayed drilling projects. Specifically then, is the oil price really at 'Comfortable' levels? Go, figure out.

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