Forget squabbles among individual members of the Organization of Petroleum Exporting Countries. Forget minor controversies stirred up by a US energy secretary testing the limits of his influence. The important problem for the oil market is that OPEC responds too slowly to reversals in demand for oil.
At every turn in the violent cycle that began with the Asian economic crash of 1997-98 and from which the market has yet to right itself, OPEC has been too slow to recognize demand shifts and too slow to adjust production.
The scorecard
In late 1997, the exporters' group was hardly alone in underestimating the depth and duration of the Asian recession and consequent slump in oil demand. It nevertheless acted in the wrong direction with its now infamous quota increase in November of that year. And throughout 1998 it chased a market in rapid decline with baby-step production adjustments undertaken only when nonmember exporters offered parallel cuts.
It wasn't until national treasuries of the oil-dependent countries of the Persian Gulf were in such poor shape that political instability loomed that the exporters meaningfully reduced output. By then, the commercial petroleum industry was supine. By then, OPEC members had no choice but to act.
On the high end of the price cycle, OPEC's performance has been no better. Again, the group waited too long to adjust quotas and production levels, which are never the same thing. Despite last week's announced production increases, product prices remain high and will stay that way until inventories climb back to safe levels, possibly forestalling the Asian recovery crucial to future demand. Growth in consumption, in any event, will suffer. And there's no telling what political mischief will emerge in the US, which has a presidential election in November and where popular anger at OPEC is once again extreme.
The world's essential adjustment mechanism for the supply of crude oil thus has a 33% success rate in the major production decisions it has been called upon to make since late 1997-if scoring ignores the two false starts leading up to last year's production cut. And OPEC members made their one proper call only when extreme financial duress left them no choice.
The oil market should work better than this.
As the world's marginal supplier, OPEC must not just assess contemporaneous demand for petroleum but also act on the judgment. The job isn't easy. And there's as much peril in overreacting as there is in reacting too slowly.
The pattern is clear, however: market changes consistently outrun OPEC. The group's decision-makers are relying too much on indicators of physical-market conditions that take too long to come into focus. Even after their Vienna meeting last week, group representatives were harumphing about there being no shortage of oil and about how the world still has plenty of oil in inventory.
Yet if there were no shortage, and if inventories were sufficient, physical supplies of immediately available crude wouldn't be selling at a sharp premium to supplies for later delivery. That price pattern implies destocking and shortage. It reflects the collective experience of all buyers and sellers and is the best indicator available to OPEC of contemporaneous market conditions.
OPEC's skepticism
Yet key members of the exporters' group remain skeptical of anything that doesn't involve physical oil. That's the problem. Inventory figures are notoriously incomplete. Demand numbers begin as estimates that require months of adjustment to become accurate.
Those physical market indicators are important. But indicators from paper markets-futures and other derivative instruments-provide a better picture of immediate conditions. OPEC needs to start trusting them. Its slow responses under current practices aggravate fundamental market swings and hurt everybody.
