KUWAIT CITY, Jan 26: Crude oil prices were reasonably stable through December, rounding off a quiet 4Q 2012. The price of Kuwait Export Crude (KEC) traded in the narrow range of $104 to $108 per barrel (pb) through the month and into early January, with a dip in the first half of the month followed by a recovery later on. Similarly, Brent crude traded in a range of $107-113 pb. The main US benchmark crude — West Texas Intermediate (WTI) — saw a more constructive month, drifting up from a mid-month low of $85 to $93 by early January. In the process, the Brent-WTI spread narrowed to its lowest since September.

Perhaps surprisingly, oil prices held up well against the on-off backdrop of negotiations over the US ‘fiscal cliff’, which had threatened to push the US into recession in 2013, before a last minute deal was struck by year-end. But the absence of a market relief rally reflected a view that the US debt financing problem has been postponed rather than resolved, as well as a typical lack of trading momentum around the year-end.

On the supply side meanwhile, OPEC left its production policy unchanged, rolling over its official 30 million barrel per day (bpd) output target until its next meeting in May. Although this was widely expected and may have helped maintain market stability in the short-term, the organization was seen as having avoided the more difficult decision of how to cope with the anticipated loosening of oil market fundamentals this year whilst maintaining unity amongst its often quarrelling members.

2012 as a whole was another landmark year for crude. Most benchmark prices inched to record highs (annual average), supported by geopolitical events, disappointing non-OPEC supplies (outside of the US) and dwindling levels of OPEC spare production capacity. Brent crude, for example, averaged $112, marginally above the $111 recorded in 2011. Similarly, KEC reached $109, up from $106 the year before.

Only WTI failed to make gains, slipping $1 to $94 pb on US storage shortages and the strength of north American supplies.

Oil demand outlook
Despite the fragile global economic environment, forecasts for global oil demand growth have in some cases been revised higher over the past month. The International Energy Agency (IEA), for example, has revised up its oil demand growth forecasts for 2013 from 0.8 mbpd (0.9%) to 0.9 mbpd (1%), partly on the back of stronger than expected outturn data for 2012. The Centre for Global Energy Studies has also revised up its 2013 growth forecast from 0.7 mbpd (0.8%) to 0.9 mbpd (1%), linked to resilient demand growth in countries where local energy prices are shielded by subsidies. But note that these figures, although improved from before, remain modest by historical standards and come on the back of similarly tepid demand growth expected to have been registered last year.

Oil supply outlook
Crude output of the OPEC-11 (i.e. excluding Iraq) dropped by a substantial 220,000 bpd in November to 27.6 mbpd — the lowest level seen in over a year. Around 100,000 bpd of this decline came from Nigeria, where output continued to be affected by severe flooding in the oil producing Niger River Delta region. Saudi Arabia also saw output reduced by some 48,000 bpd, though official government figures point to much larger cutbacks of more than 200,000 bpd. Separate data from ‘direct communication’ show additional declines from Libya (18,000 bpd) and Iran (13,000 bpd). The former has seen production hit by strikes and protests at various oil fields as well as the Ras Lanuf refinery, with output expected to have been further affected in December. Meanwhile, sanctions continue to weigh in on Iranian oil production, which has fallen by almost 1 mbpd in the past year.  

Total OPEC production (including Iraq) fell to under 30.8 mbpd, despite rising Iraqi output. Oil production there edged higher by some 11,000 bpd to 3.2 mbpd in November, nearing its pre-Iran-Iraq war capacity of 3.4 mbpd. Baghdad is looking to add some 500,000 bpd to production capacity this year, though this will be contingent on easing infrastructure bottlenecks — including pipelines and storage facilities — as well as resolving ongoing disputes with the Kurdistan Regional Government.

After rising by around 0.8 mbpd in 2012, non-OPEC supplies are expected to climb by more than 1 mbpd this year. Less than one-third of this increase is expected to come from OPEC natural gas liquids (NGLs). North American production is likely to drive this expected surge in non-OPEC supplies in 2013, with the IEA projecting a significant 0.9 mbpd growth in US oil production. In total, however, global oil supplies are expected to rise more modestly this year, with cuts in OPEC output partially offsetting stronger non-OPEC supplies.

Price projections
Due to the impact of rising non-OPEC supplies and modest global demand, oil market fundamental are expected to weaken through early 2013. But a significant drop in prices is likely to be mitigated by a response from OPEC. Based on a 0.3 mbpd quarter-on-quarter decline in global oil demand in 1Q13, and assuming that OPEC production cuts are more than offset by a large 0.8 mbpd increase in non-OPEC supplies, then supply will continue to exceed demand and global oil inventories could rise by around 1.2 mbpd in the first quarter. In this case, the price of KEC is expected to slip slightly, but remain supported near $100 pb.

Alternatively, oil demand could turn out stronger than expected, allowing OPEC to maintain production at current levels. But combined with rising non-OPEC supplies, oil prices are still likely to come under some downward pressure. In this scenario, the price of KEC edges down only slightly, but stays above $100 pb for most of this year.

If, on the other hand, non-OPEC supplies growth exceeds expectations, then prices are likely to fall more rapidly. In this case, the price of KEC falls below $100 pb early on in the year. However, this will prompt OPEC to make significant production cuts before mid-year in order to prevent prices from sliding further.

Budget projections
With less than three months remaining in the current fiscal year, there is limited scope for the price scenarios above to greatly affect budget outcomes for FY 2012/13. The price of KEC should end up between $104 — $106 pb this year, compared to $110 pb last year. If as we expect, spending comes in 5-10% below the government’s forecast and revenues much higher, this year’s budget surplus could end up between KD 11.4 billion and KD 13.1 billion before allocations to the Reserve Fund for Future Generations (RFFG). This would equate to 23%-26% of forecast 2012 GDP. Though the budget surplus for the first 8 months of the fiscal year has already reached KD 14.7 billion, spending is expected to accelerate in the final months, pushing the surplus back down.