Despite warnings from analysts that another production cut is not warrantedand could, in fact, endanger oil demand growth and the global economyOPEC got a decidedly bearish signal from oil markets this week, just ahead of its ministerial meeting.
As speculation mounted that another production cut was imminent last week, oil prices on Mar. 14 collapsed. NYMEX crude fell to a 2-month low of $26.41/bbl, a drop of $1.18/bbl on the day. That correlates to about $23-24/bbl for OPEC's marker basket of crudes, near the low end of its official price band of $22-28/bbl and below its unofficial target of $25/bbl.
That gave OPEC's price hawks comfort, as the group seeks to bolster sagging prices in the face of weakening demand. OPEC was expected to pare another 750,000-1 million b/d at today's meeting in Vienna. The cut is all but certain, if the volume isn't. But it will certainly be below the 2 million b/d Indonesia wants and will likely be geared to offsetting the increased production coming from Iraq.
The group already had cut its collective quota by 1.5 million b/d, effective Feb. 1, at its January meeting, citing expectations of seasonally slack demand. But the market has not yet absorbed the February cuts. And Iraqexcluded from the OPEC quota system because of UN sanctionshas sharply boosted its output. Baghdad's output spike of 320,000 b/d in February comes on top of the 500,000 b/d OPEC is currently producing in excess of its quota. It is expected to rebuild output to the 3 million b/d level it had been producing until another tiff with the UN last December.
Also underpinning the price hawks' position was IEA this week making what it called an "alarming" reduction in its estimate of 2001 global oil demand growth. IEA cited North America's slowing economy, milder winter weather, and a decline in demand owing to high oil prices. At the same time, the agency emphasized that global stocks of crude and products are now at their lowest level relative to demand since 1991.
The OPEC cuts and the outage of at least 80,000 b/d from explosions that crippled a major production facility off Brazil this week are likely to put a prop back under oil prices for the short term.
But the "alarm" that IEA raises is one that OPEC might do well to heed, before its zeal for capturing the fiscal benefits of its new-found solidarity leads to the demise of its "golden goose," demand growth; the "bird" in question seems to already have a bad case of the sniffles.
A contrarian view
Merrill Lynch offers a contrarian view, however. The analyst refutes what it sees as a myth: that a global economic slowdown will precipitate a significant retrenchment in oil prices.
Instead, Merrill Lynch sees the current situation as hearkening back to the early 1970s, in that OPEC will be successful in adjusting output to support oil prices should the global economy soften further.
The analyst noted that the concentration of spare capacity within OPEC allowed the group to support robust oil prices despite a significant slowing of the world economy in 1974-75.
"We believe that the industry contraction and lack of investment over the past 20 years has created capacity constraints in OPEC and non-OPEC [countries] comparables to those seen in the early 1970s," Merrill Lynch said.
Unlike the 1998 price slide, which was spurred by an Asian economic slowdown exacerbated by the resumption of Iraqi oil exports and a feud for market share between Saudi Arabia, the current market situation requires the Iraqi oil supplies and enjoys OPEC solidarity.
Accordingly, Merrill Lynch thinks OPEC's premeeting quota will keep oil markets balanced down to a global gross domestic product growth of 2% in 2001 and that a further cut at today's meeting of 1 million b/d will keep oil markets balanced all the way down to almost zero global GDP growth.
What the analyst does not address, however, is what this continued ratcheting downward of production to support oil prices will ultimately do to OPEC's market share or to the ripple effect of a continually deteriorating world economy on the long-term outlook for oil demand.
It still amounts to a concern that OPEC is playing another kind of game involving a bird: the game of "chicken" with long-term oil markets.
OGJ Hotline Market Pulse
Latest Prices as of March 16, 2001
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