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Energy: No mood to let up

May 16, 2002

Oil markets are once again in the news with the natural resource scaling an 8-month high of $27/ barrel before receding on belief that fears of lower inventories, going forward, were exaggerated. Oil prices (Brent blend) are currently trading at $25.9/ barrel. The bullish trend was sparked by Paris based, International Energy Agency (IEA), a market intelligence agency established by the Western world post 70's oil shock, report that oil inventories could plunge dramatically in the coming months should the cartel -- OPEC -- continue with the current curbs in crude oil production.

The Organisation of Petroleum Exporting Countries (OPEC) tightened taps on oil supply in 2001 to the tune of 3.5 m barrels. Despite the lower output, post September 11, with global economic activity coming to a standstill, oil prices crashed by an estimated 40% to $16.6/ barrel. The cartel, fearing a repeat of 1998 when oil prices touched 20-year lows of $10/ barrel, lobbied with the non-OPEC producers to cut output and restore prices to more profitable levels. Having entered an agreement, the OPEC producers cut an additional 1.5 m barrel/ day (mbd) at the start of the year along with 4-leading non-OPEC producer (Russia, Mexico, Norway and Oman), which pulled out 452,000 barrels/ day from the markets.

Since the beginning of the 2002, oil prices have put on 30% with much of the increase in the first quarter itself. The lower production coupled with a revival in the global economy, especially U.S -- largest oil consuming nation --- was likely to tighten oil markets leading to firmness in oil prices. U.S economy grew by 5.8% in the first quarter of 2002. In our oil market update, we had indicated that oil prices were likely to remain firm, as renewed oil demand from industrial and commercial activity was likely to put strain on oil stocks.

Since the last meeting in March '02, the cartel does not seem to have changed their stand of limiting oil production. On the other hand, Russia, the second largest producer, is not very happy with the current arrangement. The country is considering hiking output in June '02 after the agreement lapses. Consequently, as per reports, the cartel is expected to meet with Russia to convince them on adopting a unified stand. The next OPEC production review meeting is on June 26. Russian producers were never happy with the arrangement and are likely to push for removing curbs. Further, the Russian economy is growing rapidly, which could make a case for augmenting production. While the cartel is concerned about prices, it also has to worry about market share, which non-OPEC producers have eaten into in the last two years. Break down in consensus could lead to a market share war.

May and June are considered to be high petrol consuming months due to the summer break, which could keep markets firm, especially in the U.S. Post the summer months, demand tends to be slack, which could remove heat from the markets. Having said that, the lower seasonal demand could be eaten away by a recovering economy. Therefore, much depends on the policy adopted by the global oil producers. Also, from the third quarter, consumers tend to build up stock for the high consuming winter months. Therefore, even with a production hike, the respite could be ephemeral. July futures are trading at $27.1/ barrel.

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