Market forces versus OPEC greed?

Dec 13, 2004 01:00 AM

by Michael Glackin

As a strategy for rescuing the plummeting price of a barrel of oil, OPEC's much touted production cut was about as much use as breaking wind over a field instead of using compost. Within a few hours of the cartel's announcement, oil plunged to its lowest price since August as the market laughed off the removal of 4 % of current output.
The market should take care. Saudi Arabia, OPEC's dominant producer, is virtually alone in arguing that prices should be allowed to return to a more normal level after breaking $ 55 in October. Faced against it are Iran, Venezuela and even Kuwait, which broke ranks with Saudi Arabia and called for a formal cut in output.

Instead of worrying about protecting an unrealistic price, Saudi Arabia believes OPEC should be looking at the issue of its spare production capacity, currently at its lowest level in almost 20 years. The Saudi argument, and bear in mind that most of the world's spare capacity is under the ground in Saudi Arabia, is that global oil stocks needed to increase before the cartel embarks on any production cuts.
Saudi Arabia won the argument this time around as the move was simply to curb rampant overproduction, most of which is done by Saudi Arabia itself. But if the market reaction is anything to go by, it may find itself in a majority of one when OPEC next meets at the end of January and the issue of reducing output comes up again. With the exception of Saudi Arabia, OPEC members are pumping oil like it's going out of fashion.

Unprecedented global demand, led by China, combined with disruption in several key supply areas, not just here in the Middle East, but also in Nigeria and Venezuela, is what's been driving oil skyward. But let's get real. Despite the hue and cry earlier this year as prices soared, the market has been well supplied, and the derailment of the global economy by cripplingly high oil prices has so far failed to happen.
On top of that, the current high demand seems to be easing as China attempts to put a brake on its rapid expansion, slowing its hitherto insatiable demand for world's commodities. This is driving the price downward, but with New York crude still trading at $ 40 a barrel, it is hardly falling to bargain basement levels.

OPEC members opposed to the Saudi stance are basically being greedy. They want to keep spare capacity to a minimum since, along with all the other factors, it's a prime component of the current high price. These states have grown to like very expensive oil and have no desire to see it fall to realistic levels.
Strong oil prices and high output have seen OPEC countries' oil income soar 20 % this year, the highest level in more than 25 years. The surge in oil income is playing an almost exclusive role in strengthening the fiscal position of countries in the Middle East that incurred massive deficits during the oil price crash in 1998. A large chunk of this cash is being used to support ambitious infrastructure projects aimed at creating employment and reducing political tensions in a number of Middle East states.

Dubai offers one of the few successful examples of utilizing record revenues to fund ambitious attempts to expand and diversify its economy away from oil. The less reform minded need higher oil prices to pay for bloated welfare states. But the bottom line is that a number of OPEC countries have no desire to see a realistic market price attached to oil. They are getting used to $ 50 a barrel and want to ratchet the current still strong price back up to that level.
But it's security risks that spook the market these days. The kind of output cuts envisaged by Iran, Libya et al are unlikely to push oil back up to $ 55 a barrel and above. An interesting report by the London based Sheikh Yamani Center for Global Energy Studies, reveals that with the exception of Iraq whose output continues to swing dramatically because of sabotage, OPEC has added only a net 300,000 bpd, or 1 %, to its production capacity since 1998, when oil plunged to $ 10 a barrel. Overthe same period, world oil demand has jumped 10 %.

The cartel met this increase by using up existing spare capacity. At the same time, non-OPEC producers, most notably Russia, rapidly increased output to such an extent that OPEC issued them with a firm rebuke which effectively forced them to reduce exports.
Iranian Oil Minister Bijan Namdar Zanganeh made it clear that a further, more formal, cut was possible.
"If the market's reaction tells us it is necessary, we will do it," he said.
Well, he can try, but the market may well bite him back.

Source: The Daily Star
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