OPEC PACT NO CAUSE FOR OIL PRICE PANIC

International agreements can affect the oil market, and one agreement in particular is affecting the market now. This month's production quota agreement by the Organization of Petroleum Exporting Countries, however, is not it.

June 28, 1993

3 min read

Oil traders seem not to agree. Crude prices have slumped. At the middle of last week, most crude prices were $1/bbl or more below their levels of just before the Geneva meeting. Market observers lament OPEC's failure to produce a reasonable agreement covering production in the year's third quarter. Their assessment of the agreement is certainly valid. But does an unreasonable OPEC agreement really matter?

No it does not. Not now, at any rate.

LOW QUOTA

The OPEC agreement lacks market credibility because it sets a group production quota below all expectations for third quarter demand for OPEC crude. The group simply extended its second quarter production ceiling of 23.582 million b/d. Yet its own estimate of the third quarter call on OPEC crude, with no stock build, is 24.2 million b/d. Other estimates fall in the range of 24.5-25 million b/d. The expectation is that OPEC members will cheat in order to satisfy demand beyond the group quota.

Of course they will. Quota cheating has occurred all year. And in Geneva, Kuwait declared that it would produce as much as 2.16 million b/d-400,000 b/d more than its implied quota. The market has reacted as though these shenanigans portend another production free-for-all.

That's not likely. The Geneva meeting featured no demands for greater OPEC market share, which would indeed require a price-wrecking production spree. Most OPEC members now recognize that their collective share of the market will grow with time and that price lurches in either direction do them more harm than good.

The OPEC agreement means only two things. First, members want to raise crude prices from recent levels. Second, they can't figure out how to apportion the production restraint needed to do the job. The wish for higher prices is only natural in a period when there have been good reasons for crude to lose value, including relatively low winter demand in the industrialized world, a surplus of sour crude, and U.K. tax changes that promise a North Sea production surge early in the second half. And failure to apportion production restraint reflects friction between two important producers desperate for revenues, Kuwait and Iran.

So OPEC members will be guided in the third quarter more by the daily market signals each receives on its own than by a production agreement no one takes seriously. Why should that scare anyone? When bids for OPEC crude get too low, group members should know what-or what not-to do.

WHAT AGREEMENTS MEAN

Indeed, OPEC seems to have reached the point where its production agreements don't mean much. Its meetings now routinely concentrate on expectations for demand, as they should, and not on conflicting price fantasies, as they once did. Some meetings produce rational production agreements; some do not. That's in the nature more of international meetings than of markets.

So this agreement is a dud. Big deal. It doesn't mean OPEC members acting on the basis of their individual interests won't respond rationally to price signals. Even if the agreement had better aligned third quarter production with expected demand, it wouldn't have affected the market as much as does another international agreement now approaching its third year. That, of course, is the United Nations embargo of oil exports from Iraq.