KUWAIT CITY, Sept 15: Crude oil prices continued to surge through August, having comfortably taken out the $100 per barrel (pb) mark in July. The price of Kuwait Export Crude (KEC) rose by $10 to $111 pb between end-July and mid-August, before leveling off in the second half of the month and into September. At these levels, prices are slightly higher than the averages seen last year, though short of the highs of 2Q2012.
Meanwhile, Brent crude breached the $115 pb mark while West Texas Intermediate stood at around $96 - still a heavy discount to other global benchmarks. In general, crude prices have risen some 25% from their lows of late June.
The rise in oil prices was at least partly driven by a significant tightening of market fundamentals. Falling Iranian production, declines in North Sea output, a seasonal rise in GCC consumption and an improvement in OECD demand may have combined to move the net oil market balance from a 1 million barrel per day (mbpd) surplus in 2Q2012 to 1 mbpd deficit in 3Q.

In addition, rising geopolitical tensions over the Iranian nuclear program has seen the revival of the oil price risk premium. On the financial side, the steady two-month weakening of the US dollar - caused by a string of weak economic data and expectations of a further round of monetary easing - has supported oil prices in dollar terms.
Many analysts believe that the tightening of oil fundamentals has now abated, and that the risks to prices in 4Q2012 lay to the downside. One factor in this is the potential for a fresh release of global strategic oil reserves, as international authorities seek to ease prices to support the ailing global economy.
A one-month, 60 mbpd stock release in June 2011 saw prices drop $8 in the days immediately following its announcement, but had little lasting effect. With a US presidential election looming, this may support the case for a larger release this time around.

Outlook
Despite the fragility of the global economy, some analysts have revised upwards their projections for global oil demand growth this year. The International Energy Agency (IEA), for example, sees growth of 0.9 mbpd (1%) this year, 0.1 mbpd higher than last month. The Centre for Global Energy Studies (CGES) meanwhile, expects growth of a more subdued 0.8 mbpd, an upward revision of 0.2 mbpd. These changes partly reflect stronger than expected outturn data rather than a definite change of view about economic prospects going forward. Moreover, at below 1 mbpd, demand growth remains subdued in a historical context. Next year is expected to be a further year of sub-par growth due to a combination of high oil prices, a weak global economy and the reinstatement of nuclear capacity in Japan.

Crude output of the OPEC-11 (i.e. excluding Iraq) dropped by a substantial 274,000 bpd in July to 28.1 mbpd, the largest decline in ten months. This was led by significant declines in Iran where output fell by a whopping 173,000 bpd to 2.8 mbpd, as July saw the first full month of EU sanctions on Iranian oil exports. Libyan output dipped for the second consecutive month, by 40,000 bpd to just below 1.4 mbpd, with infrastructure problems and lack of maintenance said to have made recent output increases unsustainable. Nevertheless, a slew of maintenance programs and upstream developments could bring production to pre-crisis levels of 1.6 mbpd by year-end. A large decline of 51,000 bpd was also witnessed in Saudi Arabia with sources citing lower demand from the kingdom’s customers.

Total OPEC production (including Iraq) fell significantly to 31.2 mbpd in July, down by more than 400,000 bpd from its April peak. This came in spite of large production gains in Iraq where output hit the 3 mbpd mark for the first time since February 2002. Production was up by an impressive 115,000 bpd in July, the largest OPEC increase for the month, as new loading infrastructures enabled production gains. Further increases are expected as a result of the recommencement of the KRG’s contribution to Iraq’s oil exports. They had been halted for several months over payment disputes.
Non-OPEC supplies are now projected to increase by as little as 0.4 mbpd in 2012, with OPEC natural gas liquids (NGLs) providing the majority of the increase. Disruptions and technical outages have kept non-OPEC supplies tight in 2012, but next year should see a bounce given some supply restorations. In total, if OPEC-12 output remains at its current level, global oil supplies could rise by almost 2 mbpd in 2012.

Projections
After weakness in 2Q2012, oil market fundamentals have tightened again on the back of supply-side concerns and hopes of policy stimulus to boost the global economy. Using the CGES’s forecast of a 0.7 mbpd (0.9%) increase in demand in 2012, and assuming OPEC output increases on average by 1.4 mbpd in 2012, then supply should exceed demand this year, resulting in a stock build of 0.8 mbpd. But since most of this has already occurred, the price of KEC remains supported at above $100 pb for the rest of 2012 and into early 2013.
Alternatively, a combination of lower than expected OPEC production and stronger demand growth could lead to fresh upward pressure on oil prices. The former could come from an unwillingness by OPEC to offset lost Iranian output, while the latter could stem from government stimulus measures in the US, Europe and China. The price of KEC would rise steadily and settle at between $110-115 pb in early 2013.

If, on the other hand, non-OPEC supplies turn out 0.5 mbpd higher than expected next year as a result of partial restoration of output lost in 2012, then prices could be set on a steep downward path. In this scenario, the price of KEC falls to below $90 pb early next year, and further thereafter. This would almost certainly prompt OPEC member countries to make production cuts to prevent prices from falling further.
The three oil price scenarios described above would generate average oil prices within the range of $101 and $110 pb for FY2012/13. This is substantially higher than the $65 pb used in the Kuwaiti government’s draft budget projections.
According to press reports, budgeted spending for this fiscal year is set at KD 22 billion (though recent media sources suggest this figure could be revised up to as high as KD 24 billion once the budget is finalized).
If as we expect, spending comes in at 5-10% below the government’s forecast, the budget could see a surplus of between KD 7.7 billion and KD 12.4 billion before allocations to the Reserve Fund for Future Generations. This would equate to a surplus in the range of 16-25% of GDP, and would represent Kuwait’s 14th successive budget surplus.