YEMEN - The Oil Market Perspective.

World demand remains strong and crude oil prices are still averaging close to $34/barrel. The main drivers on the demand side are the US gasoline market and China. But beyond short-term predictions of boom, there are new warnings in the US that the world economy may eventually plunge into a long period of stagflation.

OPEC expects world oil demand to rise by some 2m b/d in the third quarter from a seasonal second quarter low, as consumption growth hits a seven-year high. Driven by strong world economic growth, the OPEC secretariat in Vienna expects oil demand to increase by another 2m b/d in the fourth quarter to hit 82.49m b/d from an expected 80.47m b/d in the third quarter. OPEC has also revised upwards its average world demand forecast for 2004 by 170,000 b/d to 80.58m b/d. This indicates growth of 2.41%, the highest rate since the 3.12% registered in 1997.

The OPEC secretariat said in its latest monthly report: "Fuelled by the remarkable pace of growth in the world economy, the strength of the ongoing surge in oil demand was not fully anticipated until rather late...The surprising record rise in consumption has led to continuous upward revisions to demand projections for 2003 and 2004, and has created a time lag in the entire supply chain".

Demand has been led by strong consumption, especially of gasoline in the run-up to the driving season in the US, where solid economic recovery is in place and inflation, although rising, "remains under control", the OPEC report said, adding: "The US recovery has the character of a strong, non-inflationary expansion led by a high and growing level of domestic demand".

OPEC said government efforts to cool the Chinese economy were beginning to take effect, potentially slowing fierce oil demand growth. Asian crude oil imports slowed in May after weaker regional demand and poor shipping economics limited buying, the monthly report said.

By end-June, OPEC's oil production including Iraq had risen to almost 29m b/d and that was a record for many years. In its monthly report, OPEC said its oil production in May had risen by 240,000 b/d to 28.2m b/d, with supply from the 10 members bound by quotas up 640,000 to 26.32m b/d. Oil production in Iraq, which has no quota, dropped by 400,000 b/d to 1.96m b/d in May and to less than 1.8m b/d in June, with the drop in June caused by repeated sabotage at its pipeline system.

Non-OPEC supply for 2004 was forecast by OPEC to rise by 1.34m b/d from the 2003 estimate to 50m b/d, with the bulk of the increase flowing from Russia and Kazakhstan. Russian oil production in June rose to more than 9.3m b/d.

After futures prices for WTI in the US spiked to 21-year highs, at one time in early June hitting a peak of $42.75/barrel, OPEC on June 3 agreed to raise its production quotas by 2m b/d from July 1 and by another 500,000 b/d from Aug. 1, taking its formal ceiling to 26m b/d. OPEC's oil ministers will meet again on July 21 in Vienna to review policy.

OPEC said in its monthly report: "Current price levels, well above the upper level of the expected [$22-28/barrel] range, are due to factors other than inventory levels. For now the market still appears to be able to absorb rising crude oil supply".

It seems that Iraq will remain a wild card for quite sometime. As one of two major crude oil pipelines in southern Iraq began carrying oil again after a pair of explosions shut down oil exports in mid-June, an investigation within the state-owned South Oil Company focused on current and former employees who may have given inside information to the saboteurs to guide their attacks. This means sabotage may recur at any time.

Insurgents, now mainly featuring Wahhabi militants (see News Service of this week's APS Diplomat), have increasingly singled out Iraq's infrastructure, with an eye to disrupting the country after a June 30 handover of sovereignty from a US-led occupation authority to a new Iraqi government. A South Oil official on June 22 said one working theory was that technical experts sympathetic to Saddam Hussein's Baathist regime - either castoffs or current employees - must have been involved in the sabotage.

Factors keeping oil prices high this week was a strike in Norway which caused oil production to fall by almost 400,000 b/d, unrest in Nigeria and - more seriously - an escalating civil war in Saudi Arabia. Crude oil prices have a speculative premium of about $10-12/barrel. This could go up sharply in mid-August if unrest over a recall referendum against President Chavez causes a disruption in Venezuelan oil exports to the US.

If oil demand continues to grow as strongly as it has over the past year and a half, OPEC's spare production capacity will soon be eroded. Saudi Arabia, now producing about 9.2m b/d, is the only country in the world with a spare capacity of 1.3m b/d.

The need for OPEC to increase its oil production capacity was debated at at its long-term strategy meeting in Beirut on June 4. Venezuelan Energy Minister Rafael Ramirez then said: "OPEC is now going close to its maximum capacity, this is an element that the market is concerned about and an issue that we as OPEC have to take into consideration..."

OPEC has lost about 1.5m b/d of capacity over the past two years because of the Venezuelan oil workers' strike, the long-term decline in Indonesia's output and ethnic conflict in the Niger Delta in Nigeria, which has reduced capacity. The robustness of Saudi Arabia's production potential will be tested towards the end of the year when it is expected to tap further into its idle capacity to accommodate the seasonal increase in demand.