January 07, 2007	Sunday	Zilhaj 16, 1427

RIYADH, Jan 6: Weakening fundamentals and softening crude markets marked the advent of the New Year, as an exceptional year whizzed by. With crude prices receding into the mid-50s, below the purported $60 a barrel Opec baseline, global markets seem to be adjusting to new realities now.

With bulls reigning, crude prices registered extreme fluctuations of almost $20 a barrel during the year but oil producers had little concerns. Output quota constraints were minimal, rather non-existing. Firm markets, with prices scaling previously untouched heights, though still behind the absolute real peaks reached in 1980, oil producers registered exceptional budget surpluses.

Rising supplies and easing regional, geopolitical tensions though forced shifting emphasis in the later half of the year, on market fundamentals, leading to a sharp correction in prices -- 27 per cent since the August heights.

Another interesting feature of the crude markets the last year was continued robust global economic growth. However, this was not matched by corresponding growth in oil demand. Conservation finally seemed to be playing its role. A particularly mild winter, rising prices and the removal of subsidies in some developing countries, dampened oil demand growth, resulting in progressive downward revisions in demand forecasts as the year unfolded.

According to the Opec, the global oil demand growth during 2006 expanded by 1.2 per cent or 1.0 million bpd to average 84.3 million bpd, representing a downward revision of 0.5 million bpd from the initial forecast of 1.5 million bpd.

The IEA also projects a weakening demand scenario as it projects the global oil product demand in 2006 to remain unchanged at 84.5 million bpd from its earlier forecast.

The IEA demand forecast for 2007, however, stands at 85.9 million barrels a day (+1.7 per cent). This 2007 forecast though faces downside risks, due to the uncertainties surrounding the US economy. China’s 2006 demand growth rate has also now been revised down to 5.6 per cent given weak apparent demand over the past three months.

Weakening fundamentals and softening markets thus seem to be ruling the crude markets as the New Year begins.

“Things seem to be returning to a more typical crude oil market where prices are dependent on Opec restraint for support," Tim Evans, an energy analyst at Citigroup in New York, was quoted by Dow Jones as saying.

For the next few months, analysts thus appear increasingly focused on the resolve of the Opec to cut output. After months, rather years of debate that the global crude demand is about to outstrip supplies and disturb the precarious demand-supply balance, any time soon, the changing market scenario is that of oversupplies.

Industry is beginning to discuss the possibility of a supply bubble. What a turnaround indeed from the peak oil theory scenarios!

After years of maintaining an open-taps policy, the Organization of the Petroleum Exporting Countries is thus faced with the ominous task of restraining output to keep oil prices at a ‘fair level.’ It is, therefore, "increasingly likely that additional Opec production cuts will be required during 2007 to avert a further slide in the oil price," Deutsche Bank said in a recent research note.

And the process of cutting output is not only divisive but is also painful. However, despite being painful, to a very large extent the Opec has succeeded in achieving its objectives in the past by using this tool. Deutsche Bank studied the response of oil prices to the 10 Opec production quota reductions between 1993 and 2004 and found that Opec has had a 70 per cent success rate of defending or pushing prices higher during a three-month window.

On the two occasions, Opec cuts did not prove effective, in 1998 and 2001, the bank concluded, as the cartel did not cut output fast enough in the face of global economic growth falling below three per cent, the report argued.

With global economic growth projected at four per cent this year, the "Opec is in a strong position to defend the oil price via production cuts," Deutsche Bank added.

For much of the last five years, Opec members pumped all they could as rapidly rising world oil demand and geopolitical worries -- from the war in Iraq to the nuclear dispute with Iran -- lifted oil prices. But as prices tumble and market softens, Opec’s action -- or inaction -- would be increasingly under prism.

Over the last couple of months, Opec has resorted to output cut twice. Opec's first production cut, of 1.2 million barrels a day, went into effect on Nov 1.

Opec, however, deferred, some insist on political grounds, the next output cut until February this year.

Many analysts continue to question the compliance of Opec to the announced output cuts. Some analysts argue that to-date the output cut has ranged between 700,000 and 800,000 barrels a day only.

The onus for these cuts, it seems, would be on the Opec kingpin Saudi Arabia. The London-based Centre for Global Energy Studies, CGES, insists in its Monthly Oil Report that over the next few months, the path of oil prices would be determined to a large extent by the ability and the willingness of Saudi Arabia . The report goes on to insist, “if the burden of acting as (price) regulator, becomes too great, it (Saudi Arabia) will demand real output cuts oil from fellow Opec members” -- apparently signalling the increasing role of Saudi Arabia in ensuring price stability. Term it returning to the old days of the Saudi role as the global swing producer if one wanted to say so, the CGES report signalled.

The question thus remains how markets would behave in this New Year?

The Deutsche Bank expects oil prices to average $62.00 a barrel this year, down from an average of more than $66.00 a barrel in 2006. However, despite bulls such as Goldman Sachs see the return of $70-plus oil this year, most analysts are looking for flat to lower prices.

"Right now, I don't think records are in the cards," Dow Jones quoted Mike Zarembski, an analyst at Chicago-based retail brokerage Xpresstrade.

"Barring any kind of military confrontation, prices will stay in the $60 to $70 range through most of 2007."

The supply and demand forces appear to have reasserted themselves for the first time in years, it now seems apparent. With consumers reining in demand and producers, including non-Opec ones, increasing output in response to higher prices, bears appear to be in control of the markets in the short-to-medium term at least.