OPEC price defense the group's long-run threat?

Nov. 1, 2002
Is OPEC's rigorous defense of price a long-term threat to its own interests? A look at OPEC oil revenue trends tells the tale.

The Organization of Petroleum Exporting Countries faces daunting challenges in managing oil markets in the short term as well as the long term.

While the short-term outlook is more readily definable, it nevertheless presents a serious challenge to the group: whether or not to simply roll over quotas in December in order to keep oil prices (OPEC basket) near $25/bbl. Now that the main market driver from the geopolitical side has become more attenuated with the US initiative against Iraq getting bogged down in the United Nations, managing the market becomes a case of "calibrating" quotabreaking to match expected winter demand. So far this year OPEC's cheating has kept the US-Iraq "war premium" bottled up to the point of holding the OPEC basket price mostly below $28/bbl, the upper end of the group's target range and automatic trigger for production cuts. If cold weather spikes demand and oil prices follow suit, OPEC could simply agree to have quotas boosted to match its production. If early winter demand falls short of expectations, then OPEC is likely to hold to quotas but talk up restraint on cheating.

The long term holds a bigger question: Is the pursuit of such a high oil price even wise in the long term for OPEC?

Export revenues

At first glance, a simplistic view of the situation would hold that any efforts to sustain high oil prices would be a net benefit to OPEC financially: production restraint = higher oil prices = higher revenues.

But in truth, claims London-based think tank Centre for Global Energy Studies, oil prices in excess of $25/bbl are harmful not only to global economic growth but also to OPEC itself.

"Curtailing oil production in order to push oil prices up is like launching a boomerang: It looks as if it could not possibly cause any harm, yet it will often return to inflict damage on the unwary," CGES said in an Oct. 18 market report. "In OPEC's case, it takes time for the adverse consequences of its output policies to rebound on the organization, which is perhaps why it perseveres with policies that are detrimental to its longer-term interests."

The rationale here that is the simplistic equation shown above isn't really working for the long term. Despite the group's success in restraining production and keeping oil prices buoyed for much of the last few years, the revenues that OPEC earns from exporting oil have not been on a rising trend during that time.

The group's strategy was a success all the way around at the end of the 1990s: By 2000, OPEC's gross oil export revenues had rocketed to $224 billion in 2000 from $103 billion in 1998 and $134 billion in 1998. Since the global economic slump began in summer 2001, it was exacerbated not only by the Sept. 11, 2001, terrorist attacks on the US, but also by persistently high oil prices. That trend slashed demand, which in turn pulled oil prices back down, in the process cutting OPEC revenues by 22% last year.

"Yet instead of going with the flow of events, OPEC sought—atavistically, some would argue—to force oil prices back up again by slashing production . . .," CGES said. "Oil prices have indeed recovered in 2002, but it will have taken a year-on-year decline of 7% in production to achieve such a price rise, leaving OPEC's revenues 3% down on 2001."

Long-term perspective

CGES forecasts that global oil demand in 2003 will rise a mere 0.8%. Together with a 4% projected rise in OPEC oil output, that yields only a 6% increase in OPEC revenues with flat oil prices.

That outlook echoes a long-term perspective on OPEC revenues. CGES contends that OPEC oil export revenues have been stagnating for years, in real terms, since falling below $200 billion in 1985. Only in 1990 and 2000 has that level been exceeded since then.

An output cut by OPEC bolsters revenues in the long term only if oil demand and non-OPEC supply remain insensitive to price changes. That's unlikely, so a series of cuts will spur revenue declines in the long run as demand shrinks and non-OPEC output grows.

"OPEC will thus need to reassess its current policy of keeping oil prices high by curtailing oil production if it wants to place its revenues on a permanently upward path," CGES said.

And that job will just get tougher with a post-Saddam Hussein Iraq.

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