Another OPEC cut possible this week; is it justified?

Will OPEC proceed with another production cut at its ministerial meeting in Vienna this week? And will it be justified?

Th 0309hot1

Will OPEC proceed with another production cut at its ministerial meeting in Vienna this week? And will it be justified?

There are some signs that a bear market may be getting entrenched, contends WEFA Energy Services' Michael Lynch. Recent bullish market and political events have failed to strengthen oil prices, which have remained under pressure from weakening demand, he says. WTI closed out last month just above $27/bbl, edging closer to the lows seen in second quarter 2000.

The one major factor putting upward pressure on oil prices in early March has been the anticipation of possible further cuts in OPEC production. Ironically, OPEC itself may have talked up the price to the point where it may seem to obviate the need for another cut–which suggests that prices have room to slide again after the meeting if no cut is forthcoming.

"If, as some reports have it, the Saudis are playing a delicate balancing act, trying to keep the [OPEC basket] price at $25/bbl, not just above it, then the near-term price will be more influential on OPEC deliberations than usual," Lynch said.

Capacity growth

At the same time demand is weakening, higher oil prices have begun to spawn another round of oil production capacity growth within and outside OPEC.

Lynch estimates non-OPEC production capacity growth this year at 1 million b/d, compared with projections of 700,000 b/d, 800,000 b/d, and 600,000 b/d by, respectively, Deutsche Bank, IEA, and EIA.

At the same time, OPEC's surplus productive capacity is growing again, after taking a nosedive in second half 2000. Even with the recent quota reductions that have resulted in reduced output, there is evidence of a growing capacity surplus, Lynch contends

During 2001-02, he estimates, planned capacity additions in OPEC total more than 3 million b/d, "However, the increases in Nigeria and Venezuela, in particular, are almost certainly exaggerated, and the others are likely to see some adjustment if and when markets are weak," he said. "As a result, 1 million b/d is a more reasonable estimate of the likely increase in OPEC capacity by yearend, excluding Saudi plans."

Pressure to cheat

The expanding capacity surplus within OPEC is spurring a growing temptation by some members to cheat on quotas. Essentially, the market until recently has been so strong that OPEC discipline has been largely irrelevant.

Lynch points out that some of the OPEC nations, notably Venezuela, have asked foreign investors to absorb some of the OPEC quota cuts.

But, in fact, the rising capacity operated by these foreign firms puts more pressure on OPEC governments to seek higher quotas or cheat, he contends.

"The result is that surplus capacity within OPEC would start to resemble what was seen during the Asian economic collapse of 1998."

But if the added volumes from cheating are as trivial as is likely and if OPEC discipline continues to hold, then Lynch thinks that boosts chances the group can stabilize markets in the middle or upper end of its $22-28/bbl basket marker price band.

OGJ Hotline Market Pulse
Latest Prices as of March 9, 2001

Click here to enlarge image

null

Click here to enlarge image

null

Nymex unleaded

Click here to enlarge image

null

Nymex heating oil

Click here to enlarge image

null

IPE Gas oil

Click here to enlarge image

null

Nymex natural gas

Click here to enlarge image

null

*Futures price, next month delivery. #Spot price

More in Production Operations