Only in the whimsical world of OPEC can a decision to allow greater production also be a production cut. The Organization of Petroleum Exporting Countries' Aug. 24 decision to cut output while hiking quotas was met with some dismay by analysts who had already factored quota cuts into their forecasting models. Some of these analysts indignantly complained that the "confusing" decision sends mixed signals to the market.
To which the only response can be: Well, duh.
Setting aside the obvious question of whether traders ever could respond rationally to OPEC moves anyway, sending a mixed signal is exactly the right thing to do, from the organization's standpoint. Factoring in current OPEC internal politics, volatile geopolitics, and a wildly uncertain supply-demand outlook, a have-it-both-ways decision is about the only way the group could move and still minimize fallout.
Cut or increase?
It's pretty clear that OPEC wants to eat its cake and have it too in its agreement to cut output by 2 million b/d now but hike quotas by 900,000 b/d June 1.
The group's decision gives it the luxury of 2 more months for commercial oil stocks to rebuild ahead of the summer driving season. That's also 2 more months for markets to get a better gauge on how soon Iraqi supplies may reach the market. While a few Iraqi wells were already back on line at the end of April, a dispute over whether the US or the United Nations would oversee oil sales could delay the return of Iraqi oil to the market for months. It may have been just coincidence that OPEC's new quota kicks in about the same time as the expiration of the currently suspended, UN-administered Iraqi oil-for-aid sales program. But it certainly is propitious timing.
OPEC's decision gives it the impression of seeking to bolster prices by reducing supply but at the same leaves room for adding supply later so as to not appear to be war profiteering or seizing market share owing to Iraq's exit from the market during Gulf War I.
More cuts
Some analysts also squawked that the higher production numbers cited in the OPEC accord don't jibe with the actual volumes reaching the market. The disparity is about 1 million b/d, and the complaint was that the 2 million b/d cut is really about half that.
What they forgot is that quotas govern production, not supply.
It is likely that the Saudis really were producing as much as they say they were—but diverted into storage much of that incremental production for several weeks near the start of the war. This was a cushion intended as much as anything to stave off the release of strategic stocks from the US or via international emergency oil-sharing accords as the military tensions worsened.
This cushion was a simple extension of the strategy inherent in OPEC's February agreement to simply reaffirm quotas, despite widespread calls for the group to boost quotas. At the same time, OPEC (especially the Saudis) continually reassured the market that supplies would be ample. This also was a mixed signal, but in another sense it was a pretty clear signal to the market that said: "We don't want to officially endorse a quota increase now, because that could be read as an endorsement of the US-led incursion into Iraq. However, we will wilfully flaunt our own quotas to ensure the market isn't shorted."
Well, it worked. Oil prices failed to crack $40/bbl amid economic jitters and war, and the moderate Islamic states of the Persian Gulf were able to save face.
With the new output cuts, OPEC reassures the market that it will continue to defend its $22-28/bbl (OPEC basket) target price. And with the new quotas, OPEC pacifies the demands for higher quotas from the likes of Nigeria and Algeria—but spreads the extra 3.7% around, to be "fair" (a moot point for countries such as Indonesia and Iran that can barely produce to quota).
With June comes the wrangling over the oil-for-aid program, disposition of Iraqi oil sales, and a (hoped-for) clearer picture of second-half demand and of the timing for reviving Iraqi output.
The summer could also turn violent again in Nigeria, Venezuela, and now Indonesia, so those higher quotas may be needed.
Another production cut or quota rollback could come in June, but the Saudis likely will keep a lot of that recently produced extra crude in storage, just as they did at the outset of the war: From swing producer to swing cushion.
(Online Apr. 25; author's e-mail: [email protected])
