A combination of strong OPEC oil supplies and fears over the weakness of the world economy - including the US and China - drove initial declines of oil prices, said a report by a local bank.

"Crude prices fell significantly to mid-June, before regaining some ground on hopes of fresh Chinese policy stimulus and the impact of sanctions on Iranian oil output.

"Increased pessimism over the outlook for the global economy has translated into expectations for muted oil demand growth in 2013. A second successive year of rising inventories is possible.

"Under some fairly soft assumptions, oil prices could average between USD 76 and USD 100 pb in FY12/13. This would generate a budget balance of KD 0.6 to 9 bn for Kuwait this year, said the National Bank of Kuwait in its weekly report.

Crude oil prices continued their precipitous slide through most of June, but recovered slightly towards the end of the month and into July.

The price of Kuwait Export Crude (KEC) fell from USD 100 per barrel (pb) at the end of May to an 18-month low of USD 88 on 22nd June, taking the 3-month peak-to-trough decline to 29pct. By early July, however, KEC had bounced back by USD 10 to USD 97, reducing the fall to 21pct. Brent crude hovered close to USD 100 in early July, having also fallen to USD 88 in June. West Texas Intermediate (WTI) - the main US benchmark crude - fell as low as USD 78 pb before recovering to USD 87.

A combination of strong OPEC supplies and fears over the weakness of the world economy - including the US and China - drove the initial declines. The prospect of a sharp slowdown in the Chinese economy in particular has reinforced worries that the decade-long 'supercycle' in commodities may be ending. This has driven falls in prices across the commodity asset class as investors seek to reposition themselves. The prices of industrial metals such as aluminum and copper have also dropped significantly.

The partial rebound in prices in late June was driven by a reversal of some of these concerns. On the supply side, attention shifted to news that Iranian production may have fallen to below 3 million barrels per day (mbpd) for the first time since 1990 as sanctions imposed by the EU came into effect.

This puts additional pressure on other key OPEC members - mostly in the Gulf - to maintain output at its current modern day highs. On the demand side, meanwhile, weak Chinese growth figures have encouraged the belief that the Chinese authorities will embark on a fresh round of policy stimulus.

The consensus view is that oil demand will grow by a modest 0.8 to 0.9 mbpd (0.9% to 1%) this year, with significant falls in OECD demand more than offset by the continued rise in non-OECD demand.

The Centre for Global Energy Studies (CGES), however, maintains a softer forecast of growth of just 0.6 mbpd (0.7%). Although pessimism about the global economy has increased, this has tended to show up in the figures for 2013.

Demand growth is generally expected to remain sub-1 mbpd next year, with non-OECD countries again contributing all of the increase. From a structural perspective, 2013 will be a landmark year: demand from outside the OECD, at more than 45 mbpd, is expected to exceed that from within the OECD for the first time.

Crude output of the OPEC-11 (i.e. excluding Iraq) edged marginally lower by 17,000 bpd in May to 28.6 mbpd. The largest decline came from sanction-induced falls in Iran where output fell by some 72,000 bpd to 3.1 mbpd, almost 400 kbpd below end-2011 levels.

The EU embargo that came into effect at the start of this month will likely lead to further production declines in the second half of the year as Iranian storage facilities reach full capacity. Meanwhile, Libyan output continues to soar (an increase of 58,000 bpd for the month) with production currently running at 90pct of pre-war capacity of 1.6 mbpd.

According to figures from 'direct communication', or governments' estimates, Iran has reported that its output has continued to rise steadily, while Saudi figures show that production eased by about 300,000 bpd in May, possibly in response to weakening prices.

Total OPEC production (including Iraq) slipped slightly to just below 31.6 mbpd in May, ending a seven-month run of increases.

During the OPEC meeting in Vienna last month, OPEC members agreed to maintain their current output ceiling of 30 mbpd, effectively leaving the rate of overproduction at 1.6 mbpd.

Official end of year figures for the fiscal year 2011/12 have not yet been released, but we expect government revenues to have reached almost KD 30 billion, or 40pct higher than the previous year, on the back of record oil prices which averaged USD 110 pb. If as we expect, spending comes in at 5-10% below the government's budget, last year's budget surplus could close between KD 11.4 billion and KD 12.5 billion before allocations to the Reserve Fund for Future Generations (RFFG). Official figures for the first eleven months of the year show a surplus of KD 16.1 billion, but this surplus usually declines once late spending is included. Based on the price scenarios described above, oil prices range between 76 and 100 pb in FY 2012/13, although we believe they are more likely to average near the upper range. According to press reports, budgeted spending for this fiscal year is set at KD 22 billion, but the number could subsequently be revised up.

Assuming that spending comes in below budget, NBK projected a surplus of between KD 0.6 billion and KD 9 billion before allocations to the RFFG, again with the higher surplus scenario as a more likely outcome. This compares to a budgeted deficit of KD 8 billion, but would be lower than the surplus recorded last year.