Calls last week for a production increase by the world's major oil exporters sounded silly. Prominent among them was one from the Democratic presidential challenger, Sen. John Kerry of Massachusetts. A Mar. 30 campaign initiative trumpeted as "John Kerry's plan to lower gas prices" pointed to the next day's meeting of the Organization of Petroleum Exporting Countries in Vienna and declared, "A Kerry administration would act immediately to exert pressure on OPEC to abandon its cut in output quotas and instead increase oil supplies."
This assertion teeters on two weak presumptions. The first is that OPEC should refrain from reducing supply as demand enters a seasonal decline. The other is that the exporters' group could, in fact, raise production enough to lower crude prices.
Market needs
Under current market conditions, trying to jawbone OPEC into a production increase would be foolish. The market needs enough crude from OPEC to satisfy current needs and replenish inventories, which since late in 2002 have been very low. The problem is determining exactly what the market needs.
Elevated prices seem not to be suppressing consumption. The International Energy Agency projects demand increases in each quarter this year from last year's levels. Since last December, it has raised its projection of the 2004 demand average by 600,000 b/d. The gains come from dollar weakness and economic strength, especially in China and other recovering countries in Asia. But no trend lasts forever.
What's certain is that demand will slump between the first and second quarters. It always does. The question is how much. Furthermore, prices can't rise indefinitely without curbing demand.
For OPEC, this all makes for tricky decision-making. Last week, when it affirmed the 1 million b/d quota cut it announced Feb. 10, the expectation for a second-quarter slump still had to be moderated by prospects for yet another upward reassessment of global consumption.
If IEA projections do hold up, in fact, OPEC's new quota of 23.5 million b/d for members other than Iraq looks reasonable for the second quarter. In its Oil Market Report for March, IEA estimated the need for OPEC crude before stock changes during the period of 23.9 million b/d, down 2.1 million b/d from the first quarter. Iraqi production of 2.5 million b/d would leave 21.4 million b/d for the other members, with 2 million b/d flooding storage in the unlikely event that they honored their quotas.
These numbers do not beg for a boost to production anytime in the next 3 months. Even if they did, OPEC members would be imprudent to comply.
At recent rates of production, the group doesn't have much spare capacity. IEA puts the total, net of February production by members other than Iraq of 25.85 million b/d, at 1.9 million b/d. Half of that is in Saudi Arabia, which holds a further 1 million b/d of capacity able to start up within 90 days.
That's not much cushion in an 80 million b/d market. It wouldn't, for example, cover loss of production by Venezuela or Nigeria, where political tensions have curtailed supply before and might well do so again. To suppose that OPEC members should tap this thin buffer to lower gasoline prices is facile. And to expect prices to drop in a market feeding on already spare contingent supply is unrealistic.
A breather
So a fundamentally very tight market gets a breather until driving season begins. During the lull, an inventory build exceeding the usual 1 million b/d would be helpful. It's a deficiency of crude in storage relative to consumption, after all, that defines the current problem.
Relaxation of OPEC output to a level that met seasonally diminished immediate needs while allowing a stronger than normal storage fill would be just right. It also would restore some of the market's essential safety margin of production capacity idle but ready. Unless demand continues to outrun forecasts, the new quota can accommodate these needs and leave OPEC members room to meet unexpected demand gains by cheating.
Prices of crude and its derivatives are high for good reason. The market now gets the chance to work out some of its tightness. The last thing it needs is the production spurt Kerry insists US President George W. Bush should be demanding.