Hitherto unsuspected levels of discipline by both OPEC and non-OPEC oil producers has not only checked the downward trend in oil prices but has also seen those prices climbing steadily upwards. Rafiq Ahmed discusses the consequences.

The world's most heavily traded and essential commodity, crude oil, has gained considerable strength over the past year. The price of Brent Blend, the international bell-weather crude oil, had recovered from below $10 a barrel (bbl) in December of 1998, to almost $26bbl by the end of 1999.

It could surge to $28bbl or even higher in February should global inventories fall more rapidly during the first quarter of 2000. The average price for 1999 exceeded $18bbl which represented a significant rebound from a decade-low of $12.76bbl in 1998.

As a result, the leading producers have enjoyed windfalls i.e. strong cash-flows, hence leading to lower fiscal and external deficits in 1999. The Organisation of Petroleum Exporting Countries, OPEC, estimates that its 11-members' collective oil revenues were $131.6bn in 1999, a rise of $28.6bn over 1998 but still below the $149bn of 1997.

The futures market indicates stronger trends because of the northern hemisphere's winter, as supply tightens.

OPEC's Secretary-General, Rilwanu Lukman, a former Nigerian oil minister, said, "Prices have now reached levels that allow producers to earn sufficient rent and ensure security."

The global supply and demand conditions are now moving towards an equilibrium. A report by the Paris-based International Energy Agency shows that a reduction in world output of over 5m barrels per day (mb/d) since April last year, equivalent to 7% of world output, has brought supply and demand closer to a balance.

There has been surprise at OPEC's unusual self-discipline, with an overall compliance rate of between 80 to 90% of agreed cutbacks of 4.3mb/d, which is even supported by non-OPEC producers such as Mexico, Norway, Russia and Oman. This solidarity has created a substantial drawdown of global oil stocks over the past year.

OPEC's output, excluding Iraq, is running at 23.49mb/d, the same output as in 1996. Nigeria accounts for 1.98mb/d, although its capacity is thought to be 2.5mb/d.

There are estimates that there will be a record fall in stocks by as much as 3.6mb/d during the first-quarter of 2000, mostly consumed by the cold and hungry countries of the western hemisphere. Total stockpiles could dip to 2.1bn barrels by end of March.

The London-based Centre for Global Energy Studies also warns that inventories are falling rapidly in the US and Europe. It reports that stock held by major oil companies may hit a minimum operating level in early 2000, hence increasing demand on spot crude markets, amid depleting inventories.

Current higher prices also reflect speculative buying by large US hedge funds.

And the situation could worsen. A more buoyant global economy, projected to grow by 3.5% in 2000 by the OECD, should lead to higher energy consumption in America, Europe and Asia-Pacific, including Japan. Others predict demand will increase by 2.4% over 1998 consumption levels.

There is a question mark over whether the current cuts in production will be extended beyond the end of March. A combination of factors, including global growth, pricing and demand will determine OPEC's policy on future output.

Hawkish members such as Kuwait and Libya favour extending the production cuts into late 2000, in order to ensure that any oil glut is fully eliminated. But there are warnings that any prolonged cut in output would reduce world stocks to only 46 days and prices could hit $35bbl by end of 2000.

However, OPEC could sanction a modest increase in output at its March meeting, if stocks have fallen to dangerously low levels and prices are heading above $25bbl.

A prolonged era of firm prices, as during 1979-1985, when the average crude price was $32bbl, is not in the producers' long-term interest. Higher prices, if sustained for a year, would exert upward pressures on inflation and interest rates in the major OECD countries, undermining any projected growth in oil demand. It would also put South-East Asia's recovery at risk, as well as encouraging investment into alternative sources of energy.

Any higher earnings made by oil multinationals could result in larger capital investment in higher-cost regions of offshore exploration such as West Africa, the Caspian Sea, the North Sea and North America.

Paradoxically too, higher prices could increase the oil glut in the long term with increased prices stimulating more non-OPEC supplies in 2000-01.

Some argue that as a continent, Africa benefits from stronger oil prices. The region is a net exporter of crude oil, with an output of 360mt in 1998, equivalent to 10% of world production. This is against an annual consumption of 112mt.

In reality, it is only the north and some western parts of Africa that are producers. For most sub-Saharan countries higher fuel import bills create balance of payments deficits and hit economic growth, while the producers can experience spiralling inflation.

Major international oil companies are largely sceptical about the current prices being sustained. This explains why some oil companies have locked into higher futures prices by hedging their output and revenues in anticipation of a market downturn in 2000-01.

The World Bank says: "Oil prices are likely to remain under downward pressure in the longer term." The projected expansion in capacity, notably from Iraq, Iran, Kuwait, the UAE and Venezuela, as well as Nigeria and Angola, means more oil coming on stream within a few years, hence putting an effective cap on any price explosion.

In essence, the world should enjoy access to ample supplies in the new decade, barring unforeseen supply shocks.