Oil Prices: Overview of Current World Market Dynamics

Oil Prices: Overview of Current World Market Dynamics

Order Code RL31124
CRS Report for Congress
Received through the CRS Web
Oil Prices:
Overview of Current World Market Dynamics
October 26, 2001
Lawrence Kumins
Specialist in Energy Policy
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

Oil Prices: Overview of Current World Market
Dynamics
Summary
During the past three decades, oil prices have varied widely, rising after the 1973
Arab Oil Embargo, and increasing to nearly $40 per barrel after the 1979 Iranian
political upheaval. Prices declined after their 1982 peak, and collapsed in 1985 as a
result of declining demand and overproduction by members of the Organization of
Petroleum Exporting Countries (OPEC). Oil prices spiked upward when Iraq invaded
Kuwait in 1990, but declined after the Gulf Crisis passed. Throughout most of the
1990s, oil prices remained low, declining to $10 a barrel in early 1999. More
recently, however, OPEC found the supply-demand balance in world oil markets
favorable for raising prices.
The involvement of Middle Eastern terrorists in the recent attacks on the United
States has raised concern that oil production in the region might somehow be
affected. Crude oil price initially rose following the attacks. OPEC’s reaction to the
developing situation will be watched closely.
The four instances in which OPEC has succeeded in administering price increases
have all been characterized by excess production capacity lying in the range of about
4 to 5 million barrels per day (mbd) or less. Current markets have produced this
condition for OPEC, where its members’ idle capacity lies in a range where
production quotas have previously succeeded. This level of overhanging capacity,
coupled with the pain endured during the 1990s’ long drift downward to $10, has
encouraged OPEC to act with more vigor than in the past. Between the beginning of
1999 and the most recent adjustment taking effect in September 2001, OPEC adjusted
quotas eight times to successfully pursue a price range of between $22 and $28 per
average barrel produced by the cartel. As it fine tunes its operations, OPEC is
currently focused on a more specific $25 target.
OPEC faces several challenges in setting production quotas and trying to
administer prices. The most immediate is the drop in demand following the events of
September. Additionally, OPEC must make room for oil from Iraq, which began to
flow in July. While an OPEC member, Iraq is not included in the quota program. Its
exports are regulated by the United Nations under the oil-for-food program;
squabbles with UN regulators have halted exports several times. Taken together with
several members producing in excess of their national quotas, these factors have
caused OPEC crude to fall below $20 per barrel.
At issue is whether OPEC will be able to address these matters and stabilize
prices at the $25 target, or if crude oil prices will revert to the trends of the 1990s.

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Ramifications of Terrorist Attacks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Oil Prices – Supply, Demand and OPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Recent Crude Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Has OPEC Gained Pricing Traction? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Can OPEC Maintain Quota Discipline? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Uncertainty About Iraq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Managing OPEC Supply – A New Challenge? . . . . . . . . . . . . . . . . . . . . . . . . . 11
A Note on World Oil Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
List of Figures
Figure 1. Crude Prices – U.S. Imports, 1973-2000. . . . . . . . . . . . . . . . . . . . . . . 4
Figure 2. Spot Crude Prices, West Texas Intermediate,
June 2000 to August 2001($/barrel) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Figure 3. World Excess Oil Production Capacity, 1970-2001 . . . . . . . . . . . . . . 8
Figure 4. Oil Price Changes and Annual OPEC Capacity Utilization, 1972-2001 9
List of Tables
Table 1. OPEC 10 Crude Production Quotas, January 2000 to September 2001 6
Table 2. OPEC Spare Production Capacity During Price Hikes (mbd) . . . . . . . . 8
Table 3. OPEC Members September 2001 Output vs September 2001 Quota
(mbd) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Table 4. IEA World Crude Demand Estimates, 2000 to 2002 . . . . . . . . . . . . . 14

Oil Prices: Overview of Current World
Market Dynamics
Introduction
The United States plays a major role in the world oil market, consuming more
than one-quarter of all the oil used on the planet. With declining domestic
production and rising demand, the U.S. call on foreign crude supplies has been
growing rapidly. In 1991, the United States imported 7.6 million barrels per day
(mbd) of crude oil and refined products. Now, a decade later, year-to-date imports
have averaged 11.7 mbd, an increase of 54%, or 4.3 mbd.
Just as the United States is a dominant factor in global oil consumption, the
Organization of Petroleum Exporting Countries (OPEC) is a dominant factor in
world oil supply. OPEC control over supply is imperfect – and it has little influence
on demand. It has been able to assert control over prices only when there is no
large imbalance between supply and demand, such that it would have to manage a
large amount of potential oversupply. There have been four periods when OPEC
has enjoyed this confluence of supply and demand and taken advantage of the
situation to raise prices above long-term trends. Figure 1 illustrates this.
OPEC is now enjoying such a period. Crude prices have been ratcheted up
from $10 per barrel in early 1999 to a high exceeding $30 in 2000. Prices are now
in flux as OPEC attempts to maintain a $25 price target. OPEC officials contend
that 1 mbd of supply reduction is now necessary to hold a target price that is two
and a half times what crude prices were just two years ago.
Does U.S. demand for OPEC oil play a role in OPEC’s ability to administer
prices? Is the relentless growth in U.S. oil imports placing pricing power in
OPEC’s hands? Without the increased U.S. call on foreign oil, would OPEC be in
a position to even consider establishing a $25 price? Will OPEC policy be affected
by the U.S. response to the September 11 terrorist attacks, or by a possible U.S.
recession? This report briefly examines the major parameters of the world oil
market to provide perspective on those questions.
Ramifications of Terrorist Attacks
The involvement of Middle Eastern terrorists in the recent attacks on the
United States has raised concern that oil production in the region might somehow
be affected. Concerns about supply disruptions resulted in an initial rise in crude oil
prices. Called into question is the extent to which these fears are realistic in light of
oil market fundamentals and how OPEC might react to the developing situation.

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In the immediate reaction to the attack, prices for North Sea Brent crude for
prompt delivery surged by $3.60 per barrel to $31.05, a nine-month high. In
subsequent trading on the International Petroleum Exchange in London, prices
backed off $2 per barrel to $29.06 for the benchmark Brent crude. Trading for
prompt delivery contracts of U.S. West Texas Intermediate crude – a domestic
benchmark not traded on Wall Street – were quoted on Bloomberg at $29.10.
This was roughly $1.25 above the September 7 quote in Platts Oilgram Price
Report and consistent with London trading.
OPEC reacted to the attacks with assurances of price stability. Bloomberg
Energy News reported:
“OPEC’s members are prepared to use their spare capacity, if deemed
necessary,” to smooth prices, Secretary General Ali Rodriquez said in a
statement after the U.S. attacks. “All member countries remain
committed to strengthening market stability and ensuring that sufficient
supplies are available,” he said.
As Table 2 on page 8 below shows, OPEC currently has about 5 million
barrels per day in spare productive capacity. Over half is in Saudi Arabia (see
Table 3). It appears that enough unused capacity exists to stabilize any likely price
spike that might occur as a result of the attacks and subsequent events. Iraq – the
11th member of OPEC – is not included in Table 1 because it has no quota and
exports are controlled by the United Nations.
In addition to early concerns about global crude oil prices, there were
sporadic reports of very high retail gasoline prices. CNN.com/U.S. reported price
increases in Oklahoma City and Indianapolis,1 and lines at gas stations in the
southeastern United States. But documentation of these price concerns is thin.
CNN notes:
Some consumers suggested gas station owners were taking advantage of
a bad situation. The American Petroleum Institute, representing the
petroleum industry, echoed that thought.
Retail gasoline prices have been extremely volatile since the start of 2000,
with a tight supply-demand balance, refinery capacity and outage issues, and
pipeline transport difficulties contributing to the situation. And since September
11, gasoline prices nationwide have declined significantly, falling from $1.55 per
gallon to $1.28 in late October.
Oil Prices – Supply, Demand and OPEC
As with other internationally traded commodities, the prices for crude oil are
determined on world markets by the interaction of supply and demand. Demand is
1Gasoline prices skyrocket in some parts of the country, Sept. 12, 2001. Posted at 8:10 AM
EDT.

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determined independently by consumers globally, as they respond to their needs for
oil at its prevailing price. Supply is determined by a diversity of producers, who
attempt to meet the world’s needs in the context of prevailing prices. If more oil is
demanded than supplied, the price will rise; if more is supplied than demanded, the
price will drop. In a competitive market, all three factors — supply, demand and
price — fluctuate as supply and demand levels are constantly adjusted in trying to
reach an ongoing dynamic balance. During recent years, this process of adjustment
has resulted in very volatile prices.
In the case of crude oil, the OPEC cartel — an organization of 11 countries
that hold nearly 80% of the world’s proven oil reserves and over 40% of currently
available production capacity — attempts to set target oil prices. The extent of
OPEC’s actual influence on the world oil market is the subject of some debate.
Some hold that OPEC has little influence on crude prices because it has no control
over demand and because there are a number of large unaffiliated oil producers
around the globe. Furthermore, such skeptics about OPEC price hegemony point
to the difficulty OPEC has faced in asserting production discipline over its own
members. During its three decades as a significant entity, the cartel has frequently
faced dissension among its members on setting petroleum output levels, and once
output has been agreed upon, members have chronically overproduced.
Figure 1 traces the history of prices paid by U.S. refiners for imported crude
since the Arab Oil Embargo of 1973-74. Imports are highlighted because — as the
incremental source of supply — they tend to set prices for all petroleum
consumption. The graph below shows four periods during which oil prices took a
significant step up. Each of the first three are associated with a political event that
reduced the amount of production capacity available to supply the world market.
With the current situation, there is no political catalyst supporting OPEC. But the
supply-demand fundamentals may be stacking up it a way that makes cartel pricing
more easily administered.

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Figure 1. Crude Prices for U.S. Imports, 1973-2000
Source: Monthly Energy Review. Table 9.1 Refiner Acquisition Cost of Imported Oil.
Events reflected on the graph are:
• Arab Oil Embargo. At the outset of the embargo in 1973, Arab producers
announced a 25% reduction in petroleum output. Subsequent events involved
the eventual nationalization of oil production in most OPEC countries. Oil
prices increased three-fold.
• Iranian Political Upheaval. In 1978, protests in Iran led to a succession of
events which would lower Iranian oil output by 75% by year-end. In early
1979, the Shah left Iran, never to return. Trade with Iran was halted; the
United States had received 10% of its foreign oil supply from Iran. Iran’s 5.5
million barrels per day (mbd) of exports essentially ceased. Price impacts
reverberated for several years, ultimately resulting in U.S. crude prices more
than doubling, before falling sharply in 1985.
• Persian Gulf Crisis. Iraq invaded Kuwait in 1990, ultimately resulting in the
cessation of exports from both countries. Extra supply from other countries
quickly reduced a fly-up in worldwide prices, so that the full-year average price
registered an increase of only 20%. After the war, production increased and
prices averaged just under $18.00 for the bulk of the 1990s.
• OPEC Asserts Market Power. After averaging $12.04 for all of 1998, when oil
demand was reduced by a major financial crisis, prices returned to the 1990s
trend line only to continue higher. They averaged $27.69 for the full year 2000.
The underlying market forces causing this price rise are still being debated, but
there has been no political event to which this can be attributed.

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With regard to the most recent episode, which is still unfolding, it may well be
that OPEC’s unused productive capacity — estimated by EIA at 4 mbd 2 – is so
small that the cartel can manage the supply situation well enough to administer
price levels. By the same token, the earlier OPEC-engineered price hikes were also
associated with supply situations in which the amount of productive capacity held
off the market was in the range of 4 mbd or less. This could be the amount that
OPEC can manage. Greater amounts of idle reserves may be difficult to keep
capped, because some cartel members may face too much temptation to earn
additional revenue by exceeding their production quotas.
Recent Crude Prices
Comprehensive data on crude prices actually paid by refiners for the crude oil
they purchase are collected with a few months’ time lag. In order to assess crude
price trends as developments occur, spot crude prices for West Texas Intermediate
(WTI) are used. This price data series is available in real time, but it is not directly
comparable to the data in Figure 1 above.
WTI prices are an internationally accepted reference point for the pricing of
many different types of crude traded in transactions around the world. Absent
current figures on the actual prices U.S. refiners are paying for imported crude,
Figure 2 outlines the June 2000 – October 2001 crude price path. It shows
increasing crude prices headed into the beginning of winter, a drop in December
2000, and continued erosion through summer.
Figure 2. Spot Crude Prices, West Texas Intermediate,
June 2000 to August 2001
($/barrel)
Source: Weekly Petroleum Status Report. Table 13 – Spot Market Postings at Cushing.
2 Energy Information Administration, OPEC Fact Sheet, June 7, 2001. Page 1.

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Oil prices appear to be in decline, but they are influenced by a number of
strong crosscurrents, making interpretation (and extrapolation) of near-term trends
difficult. At this writing, it is very hard to make a guess as to the direction of
petroleum prices for the next few months. Factors at issue are the September 2001
OPEC quota, the amount of above-quota production from members producing
more than they agreed too, and the response of Iraq to the five-month extension of
the U.N. “oil for food” program made on July 5. By August, Iraqi output fully
resumed at high levels and the resulting supply to world markets is contributing to
October’s low price situation, highlighting the overproduction of some OPEC
members.
On the demand side, some question if the slow but steady growth in demand
will be affected by weakening economic growth. Major industrial economies
globally may be starting to falter, and whatever effects might result from slower
growth have not as yet revealed themselves in oil demand figures. But the outlook
for growing demand should be viewed as clouded until global economic trends
become more clear.
Has OPEC Gained Pricing Traction?
Since the start of 2000, OPEC has changed quotas much more frequently
than in the past and by larger amounts. Table 1 shows the aggregate quota for the
10 OPEC members participating in the quota program. Quotas have changed eight
times in 20 months, with quota adjustments spanning a fairly large 4 mbd range.
Table 1. OPEC 10 Crude Production Quotas,
January 2000 to September 2001
Quota Date
Quota Amount (mbd)
1/00
23.0
4/00
24.7
7/00
25.4
10/00
26.2
11/00
26.7
2/01
25.2
4/01
24.2
9/01
23.2
Source: OPEC Fact Sheet, July 6, 2000, page 3. 9/01 figure from OPEC Press Release
No. 17/2001, July 25, 2001
Comparing these data with the prices in Figure 2, it seems as though the
January 2000 quota was low enough to support substantial price increases.
Complaints from consuming nations, as well as producer concerns about

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contributing to a worldwide economic slowdown that could hurt long-term energy
demand, resulted in a succession of four quota increases during 2000. But weaker
prices during 2001 were met with three quota reductions in a row (including the
September cut now being implemented), as OPEC responded to what appears to
be diminished world crude demand.
Stated OPEC pricing policy (ratified at the January 17, 2001, OPEC meeting)
is to keep prices for the cartel’s “basket” of crudes within a band of $22 to $28 per
barrel. OPEC is more concerned about the downside of the price range. When
prices are below $22 for 10 days, cuts of 500,000 barrels per day are specified.
But these measures are not automatic; they require OPEC approval on a situation-
by-situation basis. Informal discussion indicates the price band may be evolving
into a $25 target,3 suggesting OPEC is becoming more confident in its ability to
control prices. But at this point there has been no formal agreement by the
members of the cartel on a single-number price target.
OPEC’s target prices represent sales in producing countries, and do not
include transport costs to refinery markets. Additionally, some lower-quality oils
are included, so they are not comparable on a dollar-for-dollar basis with the
landed cost of imports in the United States or with other domestic crude prices. A
rough rule of thumb is that the OPEC crude “basket” price differential compared
to NYMEX crude is $2.50 per barrel. For example, in late October, NYMEX
crude traded in the $22.50 range and the OPEC average price was roughly $20.00.
Table 1 shows that OPEC adjusted quotas eight times in less than two years.
This suggests a great deal of effort is being applied to quota-market
synchronization. And it appears as if OPEC’s efforts have borne fruit, since the
cartel has succeeded in maintaining high prices for nearly two years.
Can OPEC Maintain Quota Discipline?
At least from the start of 2000, and through mid-2001, OPEC appears to
have successfully maintained prices at levels well in excess of those prevailing
during the post-Persian Gulf Crisis years of the 1990s. Part of the cartel’s success
may well stem from the fact that excess oil production capacity worldwide is now
nearly as low as it was during the 1973 Arab Oil Embargo, with the exception of a
brief period associated with the Gulf Crisis (Desert Storm/Shield on Figure 3). The
smaller amounts of surplus capacity are more easily kept off markets than larger
surpluses, and OPEC’s success in administering prices is related to preventing
surplus capacity from becoming surplus flowing oil and greater supply.
3 “OPEC to maintain output levels: Rodriquez.” Platts Oilgram News, September 7, 2001.
p 3.

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Figure 3
Source: EIA OPEC Fact Sheet, June 7, 2001.
Table 2 below focuses on some key capacity data points in this chart that are
associated with inflection points in the price trend. Taken together with Figure 3
above, it shows that OPEC succeeded in administering price increases during
periods when there was not a great deal of surplus capacity. It may well be that the
Table 2. OPEC Spare Production Capacity During Price Hikes
(mbd)
Year
Spare Capacity
1973
3.8
1979
4.9
1991
1.7
2001
4.6
Source: Unpublished EIA data received by author via E-mail communication.

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2001 amount of excess capacity is such that OPEC can administer quotas and
maintain prices at this year’s high levels. However, market conditions after
September 11 may present challenges to those wanting to administer high prices.
While not shown in Table 2 – but depicted on Figure 3 – price declines are
associated with large amounts of excess capacity. The most graphic example here
is the large price drop in 1985, which is linked to 11.2 mbd of excess capacity.
graphically. This relationship is not mathematically precise, as the trend line drawn
by the Deutsche Bank analysis suggests. But it is strongly suggestive that a
Figure 4. Oil Price Changes and Annual OPEC
Capacity Utilization, 1972-2001
2 0 0 %
1 5 0 %
1 0 0 %
5 0 %
1 9 9 1
Change in Real Oil Price
%
0 %
1 9 9 8
nnual
A
- 5 0 %
5 0 %
6 0 %
7 0 %
8 0 %
9 0 %
1 0 0 %
1 1 0 %
A n n u a l O P E C C a p a c i ty U t i l i z a t i o n 1 9 7 2 - 2 0 0 1
S o u r c e : I E A , D O E , D e u t s c h e B a n k e s t i m a t e s
Figure 4 illustrates that the relationship between price and spare capacity
linkage does exist.
Table 3 shows data from Platt’s Oilgram Price Report showing recent
months’ output and quotas for each of the OPEC members, except for Iraq (which
has no quota).

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Table 3. OPEC Members September 2001 Output vs September
2001 Quota
(mbd)
September
September
Quota
Total
County
Output
Quota
Exceeded
Capacity
By
Algeria
0.810
0.741
.069
.975
Indonesia
1.200
1.203
(.003)
1.250
Iran
3.650
3.406
.244
3.910
Kuwait
1.970
1.861
.109
2.200
Libya
1.350
1.242
.108
1.550
Nigeria
2.220
1.911
.309
2.300
Qatar
0.660
0.601
.059
.735
Saudi
7.800
7.541
.259
10.000 to 10.500
U.A.E.
2.070
2.025
.045
2.650
Venezuela
2.700
2.670
.030
3.100
Totals
24.430
23.201
1.229
28.670 to
29.170
Source: Platt’s Oilgram Price Report, Sept. 11, 2001, page 1 and EIA OPEC Fact Sheet,
September 6, 200,1 page 6.
As the figures in Table 3 indicate, in August the 10 members with quotas
produced 1.2 million barrels per day more than they will be allowed to produce
under their September quotas. Nearly all members exceeded their quotas, some by
relatively small amounts. But Iran, Nigeria and Saudi Arabia overproduced
significantly, accounting for three-quarters of the excess, an amount of roughly
800,00 barrels per day.
Spare capacity – viewed relative to the September quota rather than actual
amounts produced – is estimated in a range of 5.5 mbd to 6.0 mbd. The range is
used by the Department of Energy (DOE) because Saudi Arabian output can be
ramped-up by an additional 0.5 mbd, given 90 days of lead time. Saudi Arabia
holds about 2.5 mbd to nearly 3.0 mbd of above-quota production capacity. Iran
holds over 500,000 barrels per day and the U.A.E. and Venezuela 625,000 and
430,000 barrels per day of over-quota capacity. Other OPEC members have
smaller amounts.
To the extent that extra capacity stays within the general magnitude of past
experiences where OPEC was able to manage output, the price target may be

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defended. But can OPEC manage over 5.5 to 6.0 mbd of actual or potential above-
quota supply and maintain a $25 price? Will a weakening global economy – and
the September 11 aftereffects – reduce oil demand? And can exports from Iraq
(not included in the quota) be accommodated? Only the passage of time will
provide answers. But, while the OPEC basket held in the $25 area through mid-
September, it fell below $20 by late October, with U.S. crudes following suit.
EIA suggests that, based on previous behavior, the September production
quota will not be met.4 This contention is based on the fact that OPEC has, from
time to time – including earlier in 2001 – overproduced stated quota levels and still
achieved desired price targets.
Uncertainty About Iraq
Iraq exports oil under U.N. Resolution 986, the so-called oil-for-food
program. Res. 986 revenues are paid to the United Nations for subsequent
disbursement for approved purchases and war reparations. Res. 986 exports are
not limited in volume; Iraq can export as much as it chooses. The Res. 986 export
program is extended for 6 month periods. Periodically, Iraq and the United Nations
disagree over ancillary terms and conditions, and Iraq has halted oil-for-food
exports. Most recently, Iraq halted Res. 986 exports on June 4, 2001, as the result
of a dispute with the United Nations concerning direct cash payments for some
portion of oil sales. Exports under Res. 986 resumed in July. For the year 2000,
Iraq had been producing 2.6 mbd – and exporting as much as 2.0 to 2.2 mbd
during periods of “normal” exports, that is in periods when Iraq was exporting at
full capability and not withholding oil during negotiations with the U.N. over the
oil for food program.5
During the first part of 2001, Iraq exports reached 2.6 mbd in some weeks.
In addition, Iraq exports just under 100,000 barrels per day to Jordan (with U.N.
approval). Other cross-border exports of oil – which are not U.N. approved – to
Syria, Iran, and Turkey may total 400,000 barrels per day. Either by displacing
other oil these countries might have imported or by transiting into world markets,
this smuggled oil adds to global supply.
By August 2001, Iraq had ramped production up to 2.9 mbd6, suggesting the
likelihood of again reaching old export amounts.
Managing OPEC Supply – A New Challenge?
With the full stream of Iraqi oil on line, it is likely that OPEC production –
Iraq is the 11th member, although it has no quota – will need adjusting to
4EIA, OPEC, September, 6 2001, page 1
5EIA, Iraq, May 2001, page 3.
6 Platts Oilgram News, OPEC August output up almost 1-mil b/d. September 11,2001, page
3.

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accommodate the renewed supply and to maintain price targets. With prices having
fallen (absent Iraq’s Res. 986 exports) from mid-June to mid-July of 2001, it seems
that the 10 OPEC quota members will have to roll back the 849,000 barrels per
day by which they have been exceeding their quotas, and further reductions in their
output may need to be made to accommodate Iraqi production.
World oil prices, as Iraq exports came back on line in July, fell into the lower
$20s, and threatened to decline further. On July 19, 2001, OPEC President Chakib
Khelil expressed worry about low prices and weak demand, indicating he was
arranging a meeting of cartel members to lower output by 1 mbd.7 At the same
time, Platts quotes an unnamed Saudi source:
Our position is clear. We will work to keep the market at the targeted
price of $25/bbl. If there is a need to cut, we will do it.8
OPEC President Khelil’s concern over a reading of $23.46 per barrel for the
OPEC basket as of July 24 trading prompted the above statement.9 This statement
announced the apparent success of a specific price target, and articulated a shift in
de facto policy to support this level, the broad $22 to $28 – while official policy –
having been rendered obsolete by better management of quotes and more regular
adjustments to track apparent demand. For the first 8 months of 2001, Platts notes
that the “OPEC basket”of crude averaged $24.75.
Proving that it would defend prices, on July 25, 2001,OPEC announced a 1
mbd cut in member quotas, reducing target output for the 10 quota nations to 23.2
mbd, effective September 1. The press release also “recognized and expressed
appreciation of the support being extended to OPEC by the Government of
Mexico”– not an OPEC member and an important source of U.S. crude. Mexico
announced a 70,000 barrel per day production cut on July 24.
Rising winter demand may help OPEC in its efforts to support prices. The
world is transitioning into the normal heating season inventory build-up. Crude
price firmness through August and into early September – with prices for WTI in
the $27 area – suggested OPEC had balanced supply and demand at least for that
time frame. But the economic fallout from the terrorist events of September 11, as
well as the full impacts of Iraq oil supply in the marketplace, is pointing toward
lower than expected oil demand. OPEC’s overproduction is clearly impacting
prices, and it is open to question whether OPEC can manage its own members’
output, deal with Iraqi production that has recovered to its previously high levels
of 2.9 mbd, and manage as much as 6.0 mbd in productive capacity that must be
kept off the market in order to stabilize prices at target levels.
7Platts Oilgram Price Report July 20,2001, Khelil to call emergency OPEC meeting, page
1.
8Platts Oilgram News, July 20, 2001, OPEC considers meeting, page 5.
9Platt’s Oilgram Price Report, July 26, 2001, OPEC cuts 1-mil, page 1.

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A Note on World Oil Demand
Estimating world oil demand is a difficult process because few countries
collect data as systematically, and in as timely a manner, as the Organization for
Economic Cooperation for Development (OECD) nations. Statistics for much of
the world’s oil consumption are not actually measured for as long as two years,
during which analysts and policymakers rely on estimates of undetermined
accuracy. For OPEC decision makers attempting to match supply with demand to
maintain a target price, lack of real-time hard data makes adjusting supply to match
demand an uncertain exercise.
The accuracy and timeliness of demand data are currently at issue. The
International Energy Agency (IEA) in August raised its demand estimates, going
back to 1999, based on the fact that actual demand had been higher than
previously tallied. Upward revisions to estimated future demand for the second
half of 2001 and all of 2002 were also called for.
In reporting the new forecasts, Platts Oilgram News noted:
The upward revision for world demand is the first since late last year,
when the agency began paring its demand forecasts to account for the
impact of rising prices. Until May, the IEA had cut its demand forecasts
six times, by a cumulative total of over 1 million barrels per day.10
One million barrels per day is the same amount by which OPEC has indicated
it would reduce output on September 1. While appearing to be a small amount in
comparison to the 76.4 mbd global average consumption for 2001, a 1 mbd
amount is sufficient, in OPEC’s estimation, to ramp-up oil prices by $3 per barrel
(from the $22 low-end of the basket to the $25 target).
OPEC was aided in its success in raising prices during 1999 and 2000 by the
fact that demand was actually stronger than statistics showed, reflecting stronger
than expected consumption. And the revised statistics11 released in August show
continued growth for the first half of 2001, which is forecast to continue into
2002. Oil demand for the full year 2001 is forecast to increase by 500,000 barrels
per day, and in 2002 by 800,000 barrels per day. While these represent small rates
of increase, they are nevertheless increases and not declines. And the amounts of
oil are significant – each demand increment eases OPEC’s task of managing its
members’ output.
Table 4 below shows IEA’s August 2001 estimate of world demand for last
year, this year, and 2002. These data show slow but steady annual demand growth.
Since they are annual data, they tend to average out seasonal swings in demand
and inventories. Table 4 also shows changed perceptions of demand growth,
reflecting new information that demand had been stronger during 2000 and the
first half of 2001 than had been previously estimated. The down-turn in world
10Platts Oilgram News, August 13, 2001. “IEA, in switch, raises estimate for oil demand.”
Page 1.
11International Energy Agency. Monthly Oil Market Report, August 10, 2001. Page 4.

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economic activity has not been reflected in lower oil demand, at least at this point
in time.
The revised historic data (for 2000) called for an upward revision of
projections for 2001 and 2002, and these revisions are shown in the last column
below. Note that the revision for 2001 increased demand growth from 100,000 to
500,000 barrels per day, a significant change in amount as well as perception. The
changed outlook suggests growing – rather than stagnant – world crude demand.
Table 4. IEA World Crude Demand Estimates, 2000 to 2002
(mbd)
Year
Annual Demand
Annual Increase
July Revision
2000
75.9
0.6
+ 0.3
2001
76.4
0.5
+ 0.4
2002
77.2
0.8
+ 0.4
Source: IEA Monthly Oil Market Report, Aug. 10, 2001, page 4.
To a large extent, the higher demand figures have supported a combination of
higher prices and more OPEC output, helping to explain why OPEC has been able
to date to hold prices in the higher part of the target price band.
Of special interest is the annual change in U.S. demand, as measured
volumetrically, in barrels per day. The EIA’s Short-Term Energy Outlook, July
2001, contains estimates of U.S. demand for the full year 2001 and 2002. EIA
notes:
Total petroleum demand in 2001 is projected to climb 220,000 barrels
per day from that of the previous year, followed by a further increase of
280,000 barrels per day in 2002.
These increases follow an increase of about 180,000 barrels per day between
1999 and 2000. Comparing these figures to the amount of revision shown in Table
4, it can be seen that U.S. demand increases – actual and forecast – account for
more than one-third the increase in global crude demand. The United States
consumes roughly one-quarter of the world’s crude.
How these revised perceptions of demand will hold up against declining
economic activity in the U.S. and abroad – as well as the direct impact of
September 11 on petroleum demand – remains an open issue. To date, lower
economic growth has not affected oil demand, although many analysts expect that
it is happening now.