The two weeks before Christmas, when the oil markets swung by more than $3 a barrel, were a foretaste of the extreme instability likely in 1988.
Right after the mid-December meeting of the Organization of Petroleum Exporting Countries failed to limit the group's overproduction, prices plunged.The betting among analysts was that prices would be under severe pressure, perhaps dropping sharply in the first quarter and being generally lower in 1988 compared with 1987.
Yet a week later, just before Christmas, prices rallied, recovering about $1.20 on the New York Mercantile Exchange and 70 cents in London in one day.
Market watchers were in no hurry to revise their projections. They attributed the partial recovery to statements by some OPEC countries that production would be cut back, to the Iraqi bombing of Iran's Larak Island oil terminal in the Persian Gulf, and to a scramble by crude oil buyers to cover short-term requirements.
The January situation amounts to a standoff, said Larry Goldstein, senior economist with the Petroleum Industry Research Foundation, New York. Buyers want the OPEC suppliers to set prices according to market conditions rather than official prices but no supplier wants to be the first to publicly break ranks, he said.
The standoff and buyers' needs to meet immediate requirements put upward
pressure on low-sulfur crudes such as North Sea Brent and West Texas Intermediate, which also are traded on the commodity markets in New York and London.
Analysts say the first quarter of 1988 will be an important test for OPEC. The first quarter is usually a seasonal slack period for buying crude. Heating oil demand is largely satisfied from inventory, and the seasonal upturn in gasoline usage is still months away.
Yet, if OPEC continues to produce at about 18 million barrels a day, there will be too much oil on the market.
A downward price spike may be seen in the first quarter, analysts say. Charles Maxwell, vice chairman of Cyrus J. Lawrence & Co., New York, says prices for OPEC crude could bottom at $12 to $14, possibly by late March or early April, and average about $16 for '88. That would put West Texas Intermediate at about $17.50 a barrel.
Ray Gibson, an industry analyst with Carl H. Pforzheimer & Co., New York, agrees that prices could bottom early in the year. He says oil could trade in a range of $14 to $20 over the 12 months, probably ending the year at about $16 for WTI.
"OPEC has shown an ability to restrain production when prices get weak, but when prices go up they tend to cheat," which would account for the large swings, Mr. Gibson said.
"OPEC will try to put it together," said Mr. Maxwell. "They'll try to maintain discipline and they'll fail; they'll have discipline and they'll fail. OPEC prices will be all over the lot," and could conceivably swing between $13 and $17 this winter, he said.
"We're not unduly alarmed about the first quarter," said a senior economist with a major international oil company who asked he not be identified.
"If you assume prices averaging $15 in 1988, that's quite an assumption. It's about $4 less than this year," he said. He noted that for the year through November, the average OPEC price was $17.15 a barrel, f.o.b, and WTI averaged $19.30.
Oil prices could range from $15 to $22 next year.
"That's quite a swing," the economist said.
Sal Ilacqua, oil analyst with Nikko Securities, New York, said he believes OPEC's prices will "be restored" to about $18 within the first six months of 1988, which would mean a WTI price of about $19.50.
"Everything revolves around 'can OPEC put its house in order.' I think they'll be able to. At $12 to $15, too many governments will fall," he said.
If forecasts of lower prices in 1988 are correct, industry observers generally don't expect the effect to be as devastating on the oil exploration sector as it was in 1986.
But as in 1986, refined products prices probably won't come down nearly as fast as crude because refiners will try to hang on to the improved margins.
"A fast drop in crude is good for refining and marketing," said George Babikian, president of Arco Petroleum Products Co., a unit of Atlantic Richfield Co., Los Angeles. Arco refines about 450,000 b/d, and is a major gasoline marketer on the West Coast.
The gross U.S. refiner margin, based on typical refinery yields, went from $2.50 to $3 a barrel in the fourth quarter of 1985 to $7.50 a barrel in the first quarter of 1986, as product prices held firm while crude declined, the oil company economist said.
By the fourth quarter of '86, crude had recovered substantially. But once product prices began falling, the competitive pressure was intense and gross
margins dropped to average $2 for the quarter.
Because the U.S. exploration sector's shakeout was so deep in 1986, industry officials don't expect major cutbacks, even if prices go down to $12.
"We all took a big hit in 1986," said a spokesman for Schlumberger Ltd., New York, a major supplier of exploration services and equipment. "The immensity and magnitude" of the decline - which saw crude drop from about $30 to $10 in seven months - left tremendous overcapacity, he said.
Officials at Baker Hughes Inc., Houston, which keeps track of the U.S. drilling rig count, said 1,995 rigs were active at the end of 1985 when WTI was about $25 a barrel. By July 1986, the rig count was down to 663 and prices were about $10.
The rig count stood at 1,168 for the week ended Dec. 18, said Baker Hughes, a major oil tool manufacturer.
The exploration sector has been largely working off a base price of $15 in 1987.
"If oil were to drop to $12, it won't be a repeat of 1986," the Schlumberger spokesman said.
Maybe not a repeat, but at $15, most larger companies can break even, said Ike Kerridge, economist of Baker Hughes. If prices drop to $11 to $12, additional cost reductions will be needed, he said.
Amoco Corp. recently announced its 1988 capital spending budget would be 15 percent higher than in 1987, much of it earmarked for exploration work.