IEEJ: June 2004

387th IEEJ Research Report Meeting
Summary
June 15, 2004

Recent International Political/Economic Situation and Oil Price Trends- Keynote Speech: Background Factors of the Recent Steep Rise in Oil Price andFuture Prospects Ken Koyama, PhD
General Manager
Energy Strategy Department
The Institute of Energy Economics, Japan<Research Objective>
The oil price soared in the international market: on June 1, 2004, the (near-term) futures
price for the WTI, world benchmark crude oil price, rose to $42.33 per barrel, reaching a record high(see Fig. 1). The average WTI price for the period from January to May 2004 also stayed at a highlevel of $36.5.
In the past, the steep rise in oil price occurred mostly in the event of disruption to oil
supply, such as the first and second oil crises, the Gulf War, and the Iraqi War, etc. This time
however, the oil price has soared above $40 despite the absence of any particular disruption of oil
supply.
There is concern that the current steep rise in the oil price could have an adverse impact on
the world economy that is currently on the road to recovery and expansion. Furthermore, the trends
in the international oil situation and oil price are major factors that have a significant influence on
the future of the world energy market and energy supply and demand.
Based on the above recognition, this report analyzes the background factors of the recent
steep rise in the oil price and then presents future prospects of the international oil situation and oilprice.

<Major Conclusions>
1. There are four major factors influencing the recent steep rise in the oil price: (1) tightening supply
and demand situation in the international oil market; (2) tightening supply and demand of gasoline in
the United States; (3) unstable situation in the Middle East; (4) impact of speculative transactions in
the oil futures market. As a result of the combination of these factors affecting and influencing one
another, the oil price has soared, despite the absence of disruption of oil supply.

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IEEJ: June 2004

2. The decline in the spare supply capacity and the buffering function for adjusting thesupply-demand balance has become obvious in the international oil market. The spare supply
capacity consists of OPEC’s spare oil production capacity, oil stock and inventory, and the (excess)oil refining capacity, each of which has decreased due to the increase in demand and the efforts of oilcompanies streamlining and cost reduction. Because of the decline in the spare supply capacity andthe buffering function for adjusting the supply-demand balance, a pattern has emerged in which theoil price is likely to fluctuate (soar) significantly depending on changes (or speculations of changes)
in supply and demand.
3. At the 131st meeting, OPEC decided to raise the production ceiling by 2 million B/D in July andadditionally by 0.5 million B/D in August. OPEC’s raising of the production ceiling is basically an
important factor that may stabilize (lower) the oil price. However, considering that the current steep
rise in the oil price has been caused by a combination of various factors, the effectiveness of OPEC
production increase is called into question, it is difficult to predict whether the OPEC’s current
decision alone can bring about the stabilization and a sharp drop in the oil price.
4. Taking the above mentioned supply-demand factors and risk factors in the Middle East intoaccount, the WTI oil price is likely to remain around the range of $35-40 for the time being. As theoil price is expected to continue fluctuating significantly in the future, it might easily go beyond or
below this range by about $3. In particular, in the event of disruption of oil supply due to terrorist
attacks in major oil producing countries such as Saudi Arabia, it cannot be denied that the oil pricecould go far beyond $40.

<Supplementary explanation>(1) World oil demand continues to grow vigorously, mainly in China and the United States (see Fig.
2). According to the International Energy Agency (IEA), in 2004, world oil demand will reach 81.08
million B/D, up 2.31 million B/D (2.9%) over the previous year. In particular, demand growth inChina is projected to be 0.79 million B/D, accounting for 34% of the world total. In response to sucha sharp increase in oil demand, both non-OPEC countries and OPEC countries increased oilproduction. According to the IEA data, as of May 2004, OPEC’s spare capacity of oil production(world’s spare supply capacity) has declined to 2.33 million B/D (1.66 million B/D, excluding Iraq),most of which is concentrated in Saudi Arabia (see Table 1).
(2) In the United States, gasoline consumption is growing strongly due to economic recovery andincrease in gasoline demand for driving. On the other hand, on the supply side, domestic refineries
are being operated almost at full capacity, resulting in the shortage of extra production capacity forgasoline. Furthermore, gasoline supply is being disturbed due to the tightened regulations ongasoline quality and the gap in such regulations among states, which prevents flexible supply
allocation/distribution. For these reasons, the gasoline price has soared in the United States,

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IEEJ: June 2004

exceeding $2 per gallon (see Fig. 3). This steep rise in the US gasoline price is an important factor
that has driven up the oil price.
(3) Under such circumstances, the unstable situation in the Middle East has become an issue ofconcern for market participants and has accelerated the price rise. In particular, two incidents ofterrorist attacks that occurred in May at oil facilities in Saudi Arabia, which is the world’s largest oil
producing country and has the world’s largest spare capacity of oil production (spare supply capacity
in an emergency), have seriously affected market sentiments. Although in reality, these incidents had
no impact on Saudi Arabia’s oil production and export capability, they have affected businesssentiments in the futures market as a destabilizing factor in the future and brought about the steep
rise in the oil price.
(4) Amid the tightening supply and demand situation and the unstable situation in the Middle East, alarge amount of speculative funds seem to be flowing into the oil futures market. In the NYMEX oilfutures trading, the long position of non-commercials (funds and general investors) has increased
significantly, reaching a record high and showing an obvious movement linked to oil price trends(see Fig. 4). Under such circumstances, the current high oil price contains a large amount of“premiums” arising from speculation caused by the unstable situation in the Middle East and theinflow of speculative funds. It is pointed out that the amount of premiums (the gap from the levelbased on supply and demand fundamentals) has reached $5-10, though it is impossible to measure
the amount precisely in terms of quantity.
(5) At the 131st meeting held on June 3, 2004, in Beirut, OPEC decided to raise the production
ceiling by 2 million B/D on July 1 and additionally by 0.5 million B/D on August 1. This decision is
OPEC’s declaration of its commitment to market stabilization. Basically, OPEC’s production
increase (increase in the production ceiling) is an important factor that could contribute to market
stabilization.
(6) However, as the actual amount of OPEC production has already exceeded the current production
ceiling (23.5 million B/D) by about 2.6 million B/D, this decision to raise the production ceiling isnothing but a confirmation of the current excess over production ceiling. Furthermore, most oil from
OPEC’s production increase is heavy crude oil, rather than light crude oil suitable for increasing
production of gasoline that is currently needed in the market. Because of these factors, theeffectiveness of OPEC’s decision is called into question. In addition, considering that the current
steep rise in oil price has been caused by the combination of various factors such as stringent supply
and demand of gasoline in the United States and the unstable situation in the Middle East, it isdifficult to predict the future oil price trends.
(7) Since the OPEC meeting, the oil price has been declining, the WTI price falling to $37 as of June9, but it still remains at a high level. Taking into account the above mentioned supply-demand
factors and risk factors in the Middle East, the WTI oil price is likely to fluctuate around the range of3

IEEJ: June 2004

$35-40 for the time being. Currently, the oil price is very likely to fluctuate significantly (highlyvolatile), and therefore there is sufficient possibility that the oil price could go beyond or below therange by $3 (or maybe more). In particular, in the event of (a fear of) disruption of oil supply due toterrorist attacks at oil facilities in major oil producing countries such as Saudi Arabia and Iraq, itcannot be denied that the oil price could further soar and go far beyond $40. If, on the contrary, (afear of) disruption of oil supply does not occur and oil supply can get through a summer with highgasoline demand in the United States, the oil price might decline sharply. For the time being though,the situation in the Middle East and the trends in the US gasoline market will continue to affect oil
price trends.

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IEEJ: June 2004

<References><Fig. 1> Trends in the WTI oil futures price (NYMEX)($/barrel)
4540
353025
20

10Jan.
Feb.
Mar.
Mar.
Apr.
May
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Mar.
Apr.
May
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Jun.
Jul.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
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May
Jun.
Jul.
Aug.
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Jun.

15

1998

2000

1999

2001

2002

2003

Source: Drawn by the author based on the NYMEX data

<Fig. 2> Trends in the world oil demand growth250(10,000 B/D)

200

OthersAsia-Pacific150

EuropeNorth America
Total

100
50
0-50
1999

2000

2001

2002

2003

Source: Drawn by the author based on the IEA, Oil Market Report

52004

2004

IEEJ: June 2004

<Table 1> OPEC oil production and excess capacity as of May 2004
Capacity of oilproduction

Production in May
2004

Excess capacity

Current production
ceiling

New production ceiling(July)

Excess in production(1,000 B/D)

(1,000 B/D)

(1,000 B/D)

(1,000 B/D)

(1,000 B/D)

(1,000 B/D)

[A]

[B]

[A-B]

[C]

OPEC 10 (except Iraq)

1,250
1,000
4,000
2,800
2,300
1,550
2,550
850
9,500
2,450
2,350
30,60027,800

1,180
970
4,000
2,130
2,300
1,510
2,330
790
8,650
2,250
2,170
28,27026,140

70
30
0670
0
40
220
60
850
200
180
2,330
1,660

OPEC 9 (except Iraq andVenezuela)

25,45023,9701,480

Algeria

Indonesia
IranIraq
Kuwait
Libya
Nigeria
Qatar
Saudi Arabia
UAE
Venezuela
Total

[B-C]

750
1,220
3,450

810
1,320
3,740

430(250)
550

1,890
1,260
1,940
610
7,640
2,050
2,700
23,5002,0501,370
2,100660
8,290
2,230
2,930
25,500

410
250
390
180
1,010
200(530)
2,640

Source: Drawn by the author based on the IEA data

<Fig. 3> Trends in the gasoline retail price in the United States
230(Cent/gallon)

210
190
170
150
130
110

Source: Drawn by the author based on the data from U.S. DOE/EIA Website

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2004/5/5

2004/1/5

2003/9/5

2003/5/5

2003/1/5

2002/9/5

2002/5/5

2002/1/5

2001/9/5

2001/5/5

2001/1/5

2000/9/5

2000/5/5

2000/1/5

1999/9/5

1999/5/5

1999/1/5

1998/9/5

1998/5/5

1998/1/5

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IEEJ: June 2004

<Fig. 4> Trends non-commercial net trading position for WIT and in the WTI futures price（USD/bbl）(Long; 1,000 bbl)
100,000

46

Futures priceNet position

80,00042

60,00038
40,00020,00034

030-20,000
26-40,000
22-60,000

5/6

4/6

3/6

2/6

1/6

12/6

11/6

9/6

10/6

8/6

7/6

6/6

5/6

4/6

3/6

2/6

1/6

12/6

11/6

9/6

10/6

8/6

7/6

6/6

5/6

2003
4/6

3/6

2/6

2002
1/6

-80,000

18(Short; 1,000 bbl)

Source: Drawn by the author based on the NYMEX data and CFTC data

Contact: ieej-info@tky.ieej.or.jp

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