OPEC sticks to its guns, but oil prices slip a bit

(Our apologies to the regular readers of this column for its recent absence. Technical problems with the revamped website made it impossible to post any of the exclusive features on OGJ Online in recent weeks. Henceforth, these exclusive features will now appear on Fridays.)

Stop me if you've heard this one: OPEC meets, pronounces its solidarity and fealty to reducing or maintaining production levels, and oil prices fall soon thereafter.

This scenario has played itself out many times in recent years. The difference is, this time OPEC has, in fact enjoyed an almost unprecedented stretch of solidarity and fealty to lower production levels, and oil prices have been flirting with $25/bbl for only the third time this decade. There were no surprises emanating from the Vienna meeting Sept. 24, with OPEC agreeing to sustain the group's production cuts totaling 2.1 million b/d, which were instituted at its March meeting following a landmark accord between Saudi Arabia, Venezuela, and Mexico on cutting production. As expected, OPEC committed to rolling over the production cuts to the end of March. In the interim, a number of OPEC ministers have pronounced themselves well-pleased with the meeting's result (although some were a bit defensive, saying the higher oil prices that would result would scarcely begin to recapture the massive losses the group suffered when oil prices where less than half current levels). Kuwait, for one, was even a bit defiant. Kuwaiti Oil Minister Sheikh Saud Nasser al-Sabah late last week said he hopes crude oil prices would hit a range of $25-28/bbl between now and next March. He followed that up by saying that OPEC has no intention of holding an extraordinary meeting, even if oil prices went beyond that range. A price of $24/bbl for Brent, he contends, would translate into an annual average-from March 1999 to March 2000-of less than $16/bbl. Saying that current oil production cuts should remain in place until world oil inventories returned to 1997 levels, al-Sabah says Kuwait would even support extending the current OPEC production cuts beyond March, if that's what it would take to draw down stocks to a manageable level again.

This all but ensures that oil prices will remain at least in the low $20s for the rest of this year and probably until next spring. Or does it?

This past week has shown cracks in this wall of presumption, and oil prices have responded by dropping by more than $2-although a good part of that was, no doubt, traders taking profits from the pre-meeting run-up. For one, rumors have been circulating that Venezuela has approached Saudi Arabia and Mexico again about perhaps increasing production in light of the potential threat to global economic recovery from high oil prices. Better take that one with a huge chunk of salt. While the new government in Caracas has been under fire for job losses stemming from production cuts, unions there have very little power, and the populace is still enamored of President Chavez (the doubling of oil revenues sure doesn't hurt, especially since refined products prices there are still regulated and crude price hikes don't get passed through).

Still, rumor moves markets, too, and perception is reality in the global oil market.

What isn't a rumor and has had an even stronger depressant effect on oil prices is this week's decision by the UN to allow Iraq to increase the dollar amount of its oil sales, under the UN-brokered oil-for-humanitarian aid program. The UN resolution lets Iraq sell an additional $3 billion worth of oil, boosting its potential revenues to about $7 billion during May 25-Nov. 21, the latest phase of the program. To a large extent, this simply reflects the rise in oil prices that has already happened and the fact that Iraq had already sold $4.87 billion worth of crude under the latest phase of the program by this month. Iraq is unlikely to be able to achieve much higher production or exports than is now the case, because it is still behind on its efforts to rehabilitate its oil fields in order to boost production. If it could, then the added supply would contribute to a weakening of prices, which, in theory, would compel Iraq to produce still more to meet its revenue target. The threat to OPEC's plans here is the prospect of this higher dollar amount getting rolled over in the next phase, which would begin near the end of November, and coinciding with added productive capacity in Iraq resulting from an accelerated rehabilitation program.

Here's an irony: OPEC's push to boost oil prices could be undermined by the one member that is completely disconnected from its efforts to rein production and only last week called on the rest of OPEC to cut production still further in order to shoot oil prices up past $30/bbl.

More analysts, notably London's Centre for Global Energy Studies, whose latest supply-demand and price scenarios are provided below, continue to call on OPEC to boost production to take the heat off prices or risk undermining global oil demand, not to mention incurring the return of non-OPEC oil with a vengeance. And others see a weakening of OPEC's cohesion, with more oil supplies "leaking" onto markets. Prices dropped almost another dollar yesterday on the word that OPEC compliance with pledged production cuts had fallen to 92% last month from the prior month level of 94%. A dollar loss with a 2-percentage-point change? That kind of shift is within a statistical margin for error (especially with the questionable reporting habits of OPEC members).

Prospects of cheating or official output increases are still possible, but OPEC has functioned so uncharacteristically this year that the best bet here seems to be the likelihood that quota-breaking (of any significance) is a thing of the past, and that OPEC is going to enjoy these higher prices a little while longer.

If, in fact, oil prices do approach $30 again, I would expect to see relief from the US SPR or IEA emergency stocks, just as happened during the Persian Gulf crisis before OPEC rides to the rescue. And that pretty well suggests a range of $20-25 through the winter.

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Table 2

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OGJ Hotline Market Pulse
Latest Prices as of October 8, 1999

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