No escape from oil price volatility

Prices that had dropped below $50 per barrel for the first time this year rebounded to $55.40 on the New York Mercantile Exchange (Nymex).

And they look set to stay high through the rest of the year according to International Energy Agency (IEA) forecasts.
 
This prognosis was supported by Royal Dutch Shell’s Global Scenarios report this week.

The oil giant forecast rising demand and prices over the next 25 years. Shell determined price volatility, such as witnessed by energy markets earlier this week, as an ongoing problem.
 
The author of the report Albert Bressand, vice president of Global Business Environment at Shell International in London, said that Shell’s three possible scenarios would mean rising energy costs between 2.6% and 3.8% a year.

In turn this would mean “far more politicised energy relations … creating new sources of tensions among countries”.

These steep rises and occasional similar falls are now becoming commonplace in oil markets. The reasons behind such volatility, however, are open to a wide degree of interpretation.
 
Ailing Saudi ruler
 
The poor health situation of King Fahd of Saudi Arabia – the world’s largest and most powerful oil exporter – was recently cited as a possible reason behind recent volatility.
 
Added to this is the psychological factor. The start of the financial third quarter of 2005, on 1 June, is predicted to see sharp increases in demand that may not be fulfilled by current production levels according to figures from the International Energy Agency. 
 

But Muhammed Ali Zainy, from the Centre of Global Energy Studies, thinks the speculation surrounding King Fahd does not hold water.
 
“It’s nothing to do with that. Crown Prince Abdullah has been the de facto ruler of Saudi Arabia for many years,” he said.

“The health situation surrounding King Fahd is not going to alter anything at all; the Saudi position will remain the same.”
 
Adding to the speculative nature of markets is the apparent lack of any prospective production increase from the next Opec meeting in Vienna. 

Opec shortfall?
 
“As well, the call for Opec alone to pump more oil is also not that important. There is enough oil to supply the market right now – stocks are rising around the world.

“The oil is there. Instead the problem is this – the basic market fundamentals. Right along the supply chain there are difficulties which need to be addressed,” Zainy told Aljazeera.net. 
 

Fears over King Fahd’s health may be fuelling oil price volatility

Bruce Evers of Investec Bank in London wonders if Opec can greatly increase their capacity at all.

“In the near term Opec will struggle to increase production, they say they can bring on new supplies but not until next year.

“There is a pick up in new rigs in Saudi Arabia but it is difficult to see how that will make a difference.
 
“Investment banker Matthew Simmons has also added to market fears. His new book Twilight In The Desert has worried a lot of people,” said Evers.
 
Simmons’ book studies Saudi Arabian reserves and concludes the amount that Saudi Arabia says it has underground, around 260 billion barrels, may be a falsehood.

Saudi reserves
 
“No one knows how much is underground in Saudi Arabia,” Simmons says.

“Some people may think they know how much is there but in reality no one does. Add to this the kind of omerta, or code of silence, that runs through their oil company Saudi Aramco and it becomes almost impossible for anyone to really know.” 
 

A combination of these factors plus bureaucracy and a lack of independent field analysis means that the reality of Saudi reserves is lost in a haze of debate rather than any factual scientific outlook.
 
Evers agrees but also acknowledges that the book may add to price volatility in the short term.
 
“It is a very detailed look at Saudi Arabia,” Evers said. “What Simmons is doing is challenging some of the basic assumptions of the market.

“He just does not believe the quantity is there [in Saudi Arabia] or that they can sustain the kind of productive capacity that will be needed to meet demand forecasts. If he is right, it is very worrying.”
 
Drilling, production elsewhere
 
But Zainy believes restricting commentary to Opec may be flawed.
 
“It is not just Opec spare production capacity that is very tight. It is everywhere. There are constraints from top to bottom in oil supply, for example look at refining or transport.

Opec is unlikely to increase oil production levels

“There is little extra capacity in either of those areas as well. If you have more oil but no way to transport it or refine it this is also a problem.”  
 
In turn, high demand levels increase volatility in these tight situations.
 
“Because we have high demand at the moment this is what creates price volatility. It could be disruption from many areas, like refining, transport or production.

“It is not just one area but all of them combined. This tightness means there is no cushion in the marketplace if anything goes wrong,” he told Aljazeera.net.
 
Analysts believe the psychology of market mechanics may also be a factor. Entering the third quarter of 2005 only adds to the reactions of the marketplace.

Market psychology 
 
“Fear enters the marketplace like this. Consumers feel that the supply links are under pressure from a variety of places, so they react very badly to any new news. It is what creates this price volatility,” Evers said.
 
He maintains that the market is looking ahead to the US holiday season when Americans take to the road, and some very bullish forecasts for the last three months of the year.
 
“The market is looking forward. Forecasts for the fourth quarter of 2005 can go as high as an extra 4mbpd. Where the hell is that going to come from?

“It just adds to the uncertainty. Will stockpiles have to be tapped? That will set off anew round of having to fill them up again.

“Also, weather forecasts for the US are very bad. The last thing we need is three to four hundred thousand barrels a day knocked out by hurricanes.”

Zainy agrees that it is the combination of factors at the moment, not one single event, that is creating worries among traders. Worries that are not about today’s situation, but rather what may occur in the future.

“Although there is nothing basically wrong with the oil supply at the moment, when traders feel the chain is constrained they can over-react. They feel there might, in the future, be disruption in supply, from say Saudi Arabia, or from Iraq, from anywhere,” he said.

“It is psychology; it does play a part, and of course so does fear.”