Growing Oil Glut Drives Down Prices : Action on Futures Market Likely to Bring Sizable Cuts
Spurred by a growing glut of oil worldwide, speculators Thursday drove down the prices they will pay for future delivery of crude and heating oil to a seven-year low. The action on New York futures markets will likely mean a sizable drop in consumer prices this spring for products such as gasoline.
Traders on the New York Mercantile Exchange were responding to reports that Saudi Arabian oil production had reached 6 million barrels per day, considerably higher than expected and much greater than the Saudis had been pumping under production quotas established by the Organization of Petroleum Exporting Countries. The Saudis have been expected to boost output for some time, after months of threatening to do so because of quota violations by other OPEC members.
Output Increasing
OPEC’s output has been increasing since the cartel decided last month to maintain its share of the declining world oil market, even if it meant boosting production to compete with cheaper sources such as Britain’s North Sea. Because the Saudis are OPEC’s biggest producer, their decision to increase output is viewed as particularly significant for world oil prices.
Although analysts said mild weather--which reduced demand for heating oil--has also contributed, energy economists said OPEC’s production is the biggest factor in a worldwide oversupply of oil that has sent oil prices tumbling in all markets.
“It’s an extraordinarily volatile period of time,” said analyst Charles Bureker of Sutro & Co. in San Francisco.
Energy analysts said it is the reverse of 1979, when oil prices surged and lines formed at gasoline stations during the crisis in Iran. The prices offered Thursday for future crude and heating oil were the lowest since early that year.
‘On the Way Down’
“Then, prices were on the way up,” said analyst Peter Beutel of Rudolf Wolff Futures, a New York brokerage. “Now we’re on the way down.”
For a so-called “benchmark” crude oil called West Texas Intermediate to be delivered in February, the futures price plummeted $1.04 to $24.11 per barrel on the Mercantile Exchange. For heating oil, the price slipped 3.2 cents to 65.55 cents a gallon.
The prices are those paid for “futures,” or contracts to buy oil delivered in February, and reflect speculators’ guesses at what market prices will be at that time. As such, futures don’t control actual prices but are a strong indicator of future price trends.
The futures market action fueled a moderate rally in the stock market, as investors responded buoyantly to expectations of cheaper oil. The Dow Jones average of 30 industrial stocks closed up 14.34 points at 1,541.63, with much of the gain coming in the latest hour after traders became aware of the oil price drop. Many stocks of oil companies, meanwhile, fell in price.
Traders didn’t have to look far Thursday to see what is happening to real-world prices beyond the futures markets. Continuing a trend that began with the Dec. 9 decision by OPEC, three major oil companies cut the prices they will pay for West Texas Intermediate to $27.25 a barrel from $28.
Futures trader Beutel said the sharp falloff in futures prices was triggered after speculators heard that the Saudis had hiked production to 6 million barrels daily, nearly triple their 2.2 million-barrel daily output of last summer.
Figure Not Confirmed
Although that figure was not confirmed, other reports from the Middle East put the early-January Saudi production at 4.8 million to 5.3 million barrels a day. In December, the production was 4.3 million to 4.8 million barrels daily, up from November’s 3.5 million to 3.7 million, these reports said.
The Saudis and several other members of the Organization of Petroleum Exporting Countries do not report their production figures, making such estimates a guessing game. Moreover, analysts cautioned that production reports can vary wildly from week to week, depending on weather, tanker schedules and other factors.
Nonetheless, analysts noted that the action in the futures market will undoubtedly affect consumer prices this spring, when oil purchased now is delivered. Gasoline prices have been relatively stable in the last month, they said, and can be expected to drop beginning next month.
A Mild Winter
The increased flow of oil from the OPEC nations is taking place amid a mild winter in Europe and the United States that has reduced demand for heating oil. Despite periods of extreme cold in the Midwest, for instance, this winter by one measurement has been 4.8% warmer than last winter.
“There’s a high level of Saudi production, a lot of oil on the seas coming toward markets and a general oversupply,” said John Lichtblau of the Petroleum Industry Research Foundation. The critical question is how far prices will fall, and there is little agreement among economists. Some doubt that the OPEC producers or the world’s major governments will let prices fall too far because of the ramifications for the economy.
When oil prices surged to near $40 a barrel from $13 just before the revolution in Iran, it spurred new production as well as major conservation measures. The gradual reversal in the supply-demand relationship started oil prices down in 1981, from $35 to about $28 at the beginning of 1985. Some have forecast a much more rapid decline to $20 a barrel or below this year.
Good News for Inflation
While the steady decline has been good news for inflation and for motorists and other major users of petroleum products, a more sudden collapse in oil prices would have serious implications for the world economy.
The collapse in revenues and profits for oil producers will ripple through thousands of other companies that service them, banks with major energy loans could be threatened, precarious oil-producing nations such as Mexico would be further jeopardized, and the world’s many deficit governments would see sharp falloffs in tax revenues.
Exploration for new reserves of oil, already in decline because the soft prices for oil reduce the payback for costly and uncertain drilling, could grind to a halt. That not only would endanger still more oil-field companies but would lead to further shrinkage of oil supplies--setting the stage for shortages in the future.
Bureker said that prices much below $20 a barrel would create major problems, creating pressure on governments to prop up prices through such measures as tariffs on imported oil.
