KUWAIT CITY, Sept 17: .Oil prices have held up well in light of intensifying global economic concerns. This is partly due to tight oil supplies. OPEC has increased oil supplies significantly to offset lost production in Libya. Despite weaker than expected oil demand growth, the world may not escape a further stock draw this year. An average oil price of $92-121 pb could yield a budget surplus of KD 4-14 bn for Kuwait’s government in FY2011/12, following a KD 5 bn surplus in FY2010/11

Oil prices
Despite mounting concerns over the strength of the global economy, oil prices generally held up well through August an early September. While the price of Kuwait Export Crude (KEC) did fall by nearly $10 per barrel (pb) to just under $100 pb at the start of August, it had recovered almost all of these loss by month-end. The prices of key global oil benchmarks also rallied: West Texas Intermediate (WTI) rose $10 to $89, while Brent had jumped $15 to $118 by early September – reaching a six week high.

The resilience of oil prices might by linked to the following factors. First, oil supplies remain tight. Although Opec increased its supplies by 1.2 million barrels per day (mbpd) between April and July, the effect on prices has been limited for a number of reasons: it had been operating ‘behind the curve’ following the loss of Libyan crude earlier in the year; the increase has reduced Opec’s spare capacity, and therefore its ability to respond to future shocks; and at least part of the increase has been absorbed by a seasonal rise in domestic consumption in the Gulf states.

Also, a weakening global economy is expected to generate pressure for further loosening (or slower tightening) of monetary and fiscal policies around the world. In the short-term at least, this may be providing support for commodities among investors and speculators. Gold for example, reached a record high of $1,900 per ounce in August, mostly on expectations of a fresh round of quantitative easing by central banks.

Oil demand outlook
Global oil demand was already expected to be modest this year, and some analysts have nudged their forecasts lower still. The CGES left its 2011 oil demand growth forecast at 0.9 mbpd (1.0%), but this was already one of the most pessimistic forecasts in the market. The International Energy Agency (IEA), has reduced its 2011 forecast by 0.1 mbpd to 1.2 mbpd (1.4%), but concedes that a weaker economic growth outcome could push down its oil demand growth forecast 0.9 mbpd, the same as the CGES. Although oil demand slowed dramatically in mid-year, it expects some 2H 2011 support from an easing of special factors in China that reduced demand growth in 1H, plus stronger demand from reconstruction and power generation needs in Japan. Analysts expect demand growth of a stronger 1.3 to 1.6 mbpd in 2012, though once again, the CGES has a more pessimistic outlook.

Oil supply outlook
Latest data shows that Opec’s crude output continued to climb in July, reaching its highest point of the cycle so far. Production of the Opec-11 (ie excluding Iraq) increased 431,000 bpd to 27.39 mbpd, mostly thanks to increases in Saudi Arabia and Angola. The three main Gulf Opec producers – Saudi Arabia, Kuwait and the UAE – have now added a combined 1.46 bmpd since January, almost offsetting the 1.56 mbpd lost from Libya. Although aggregate Opec output is likely to rise by 0.3 mbpd in 2011, the potential for further big jumps in Opec supply is unclear. Most of the organization’s 3-4 mbpd of spare capacity lies within Saudi Arabia.

Yet Saudi output – at 9.7 mbpd in July – is at previously untested levels and possibly close to the maximum sustainable rate that the Saudi authorities are comfortable with. Libyan output is expected to return to the market only gradually and over a number of years. Iraq may now offer the best hope for a substantial increase in medium-term supply, with a potential 0.3 mbpd coming on-stream by the end of this year and a further mbpd possible by the end of 2012. Outside Opec, oil supplies are expected to rise by 0.8 to 1.0 bmpd this year, boosted by the release of nearly 165,000 bpd from the IEA’s strategic reserves and up to 0.5 mbpd in Opec natural gas liquids, or NGLs. Projected non-Opec supply increases for next year are slightly larger, at 1 to 1.5 mbpd, even before the impact of the IEA’s stock release is taken out.

Price projections
The overall changes in demand and supply in 2011 look likely to be of similar size, suggesting that market fundamentals will have remained more or less unchanged this year from last. Note, however, that supply needed to have exceeded demand this year to avoid a repeat of last year’s stock draw, while Opec’s manageable cushion of spare capacity has diminished – both bullish underlying signs. Our base case is for oil prices to dip further as the global economy slows, before stabilizing into next year. The price of KEC slides to under $100 pb early in 2012, but steadies thereafter, possibly with the help of modest cuts in Opec output to ensure that oil prices remain high enough to sustain member government’s budget spending plans.

In an alternative scenario, a downturn in 2H 2011 global economic growth – from a double-dip recession in OECD economies, for example – reduces the growth in world oil demand to around 0.6 this year and 0.7 mbpd in 2012. In this case, the price of KEC would fall towards $70 bp at the start of 2012, likely prompting a large cut in Opec output during the first quarter of the year. Higher prices, on the other hand, could result if aggressive policy measures in the underdeveloped world help to resuscitate economic growth in Europe and the US. This might add some 0.3 and 0.4 mbpd to oil demand growth in 2011 and 2012, respectively. With no meaningful change in Opec output, the price of KEC could jump from $114 in 3Q 2011 to above $135 by 1Q 2012.

Budget projections
The three oil price scenarios described above would generate average oil prices within the wide band of $92 and $121 per barrel for FY2011/12, a 12%-47% increase on a year earlier. All three prices are substantially higher than the $60 pb used in the Kuwaiti government’s budget projections. If as we expect, spending comes in at 5-10% below the government’s forecast, the budget could see a surplus of between KD 4.0 billion and KD 13.6 billion before allocations to the Reserve Fund for Future Generations. This surplus is in contrast to a budgeted deficit of KD 6 billion, and would represent Kuwait’s 13th successive budget surplus.