OPEC cutback deal leaves markets in doubt

Anne Rhodes
Associate Managing Editor-News

David Knott
Senior Editor

• Where OPEC/Non-OPEC Production Cuts Will Come From [145,431 bytes]

An Organization of Petroleum Exporting Countries (OPEC) ministerial meeting on Mar. 30, intended to take the downward pressure off oil prices, has left markets with more questions than answers.

OPEC members voted to reduce their combined production, currently more than 28 million b/d, by 1.245 million b/d. Also, several non-OPEC producers, including Russia and Norway, have proposed cuts totaling a further 291,000 b/d, following on the heels of Mexico's groundbreaking agreement with Venezuela and Saudi Arabia late last month (see map). It was not certain at presstime whether the latter non-OPEC cuts were formal commitments to OPEC, as was Mexico's 100,000 b/d cut.

These moves follow the agreement by Mexico, Saudi Arabia, and Vene- zuela to rein in production and marks a complete about-face in Norway's position within a week (OGJ, Mar. 30, 1998, p. 22).

Markets greeted the OPEC meeting with skepticism. Brent crude for prompt delivery closed in London at $14.27/bbl on Mar. 30, falling 65¢/bbl on the day as fears of a weak OPEC agreement spread. Brent crude for May delivery fell 63¢/bbl on the day to $14.77/bbl.

Skepticism

Skepticism over the staying power of the OPEC agreement persisted at presstime last week.

Brent for May delivery fell a further 51¢/bbl on Mar. 31 to $14.26/bbl. This was viewed as a wait-and-see verdict on the OPEC meeting by traders.

Nymex futures saw similar declines. Nymex crude for May delivery fell 55¢/bbl to close at $16.21/bbl on May 30. On Mar. 31, Nymex crude for May fell a further 60¢ to close at $15.61/bbl.

Despite the apparent lack of confidence in OPEC's ability to make the agreement stick, this marks a substantial improvement to the recent freefall, when prompt Brent neared $11/bbl, its lowest price in 10 years.

One market analyst said markets were lowering crude prices short-term while they wait to see if OPEC will put promised cuts into practice: "It's tough to guess whether OPEC will stick to its targets. If the price rises because of the agreement, quota violations in OPEC could occur. Then the countries that agreed to cutbacks would have to act to save market share. Behind all this is a feeling that OPEC's track record says it won't obey its agreement."

Like many observers, New Orleans-based investment analyst Howard, Weil, Labouisse, Friedrichs Inc. places little credence in producer agreements such as the ones announced in recent weeks.

"These are some of the most important social, political, and economic issues facing these countriesellipseall rolled into one," said Howard Weil Pres. William H. Walker. "Everything revolves around hard currency, and oil may be the only thing (producing countries) have to trade for hard currency. So, when they start to cut back and/or the price collapses, they feel real pain, real anguish.

"These are huge geopolitical issues involving big money," said Walker, "and you don't resolve these issues in the public. These issues are resolved in smoke-filled rooms. (Producers are) very interested in solving this, but their ability to do so is, to some extent, limited."

Saudi control

"Whatever these countries do (behind closed doors), they may have to posture for the press," said Walker, "because they have political bodies they have to report to and get approval, etc.

"I'm not really interested in the press reporting either an agreement or a nonagreement, because I think that the press is going to be kept in the dark by the 'invisible hand,'"-his term for production powerhouse Saudi Arabia and its unseen dealings in oil markets.

"The invisible hand is Saudi Arabia. It's not OPEC," said Walker.

While Saudi Arabia calls its meetings with other producing countries "discussions" or "negotiations," Walker calls them, "counseling sessions." At these meetings, says Walker, Saudi Arabia basically explains to OPEC and non-OPEC producers alike that they can cut back production now or after prices fall even further.

"But if they don't start doing something, in a meaningful fashion, Saudi Arabia will put oil in the single digits. They can and they will. They are absolutely tired of being the swing producer."

"People better be aware of the potential of Saudi Arabia," added Walker. "They did this in the mid-'80s."

"When people say that our problem with oil right now is that we had a warm winter, Asian flu, and OPEC raised their production levels-all at the wrong time-who's to say that that wasn't contrived by Saudi Arabia doing exactly what they did in the mid-1980s?

"We don't know," said Walker. "All we can do is guess."

Recovery?

Walker said institutional investors are disappointed by recent deals to cut production because they want "an immediate, clear, concrete, precise solution-today.

"It ain't gonna happen that way," he said.

If the invisible hand does not work, says Walker, "the market forces will work, and the price of oil will go into the single digits, and there will be panic in the oil patch."

"Let's assume the invisible hand does work. Many people then think that the price of oil is going to turn right around-happy days are here again, it's $20/bbl.

Walker says this won't happen.

"The invisible hand works," said Walker, "but it's going to take a lot more than 1 million b/d. That won't be enough, but it's a trend. How much more? I don't know how much more. Just more."

Price collapse ahead?

Howard Weil proposes a drastic measure to return the market to normalcy.

"We think that the only way Saudi Arabia can discipline the world producers-whether OPEC or non-OPEC-is to step up its own production dramatically." This would likely cause prices to plummet, as it did when Saudi Arabia took this tack in the 1980s, bringing producers to their knees.

"We believe that Saudi Arabia will get the attention of the world producers," said Walker. "We believe, in spite of conventional wisdom, that they (other producing countries) will cut back production.

"It's a simple choice. If you listen to Saudi Arabia, you can cut back at $15/bbl. Or, you can cut back at $7/bbl. But you will cut back. You will blink. Because they're not an 800-lb gorilla, they're King Kong. They will not be a swing producer."

"We believe that, as a consequence, regardless of what you see, regardless of what you hearellipsethere will be a reduction that will cause oil to stabilize at around $15-16/bbl," said Walker. Prices will then rise gradually to $16-18/bbl by yearend, contends Howard Weil.

"And we will get back to the normal trend line, which is roughly $18-20/bbl," Walker averred.

Other views

Royal Dutch/Shell's outlook is similarly positive.

"Last year, we announced medium-term objectives based on the primary premise of $18/bbl oil," said Shell's Martin van den Bergh at Howard Weil's annual energy conference in New Orleans last week. "We still think this is a reasonable assumption on that time scale" (15 years).

Baker Hughes Inc. Chairman Max Lukens also believes the current problems are temporary. He expects oil prices to be $16-20 during the next few years.

"We have reached the point where action is being taken and spending on marginal projects is being trimmed," said Lukens. "Until (our customers) become comfortable with commodity prices, they're going to be very careful.

"Oil prices will stabilize, and our customers will stabilize their spending growth," he predicted.

Lukens said he agreed with an assessment he heard recently, calling the current problems "a pothole, not the end of the pavement."

Cause and effect

Technological advances are partly responsible for current oil prices, along with pinched Asian oil demand, increased OPEC production, and El Ni?o effects, Walker told the Howard Weil conference last week.

"Technology is what is driving this market. Demand growth cannot push prices upwards as long as it's balanced by supply growth. And the supply curves for oil are steadily being pushed down, thanks to technology.

Shell's van den Bergh agrees. "The primary cause (of low oil prices) is industry's continued success in cutting costs, increasing recovery, and accessing new reserves," he said.

"We're not bullish on oil prices," said Howard Weil's Walker. "We've never been bullish on oil prices.

"We think that, if you buy energy stocks based on commodity prices, you're making a mistake. You've got to buy them in spite of prices, not because of prices."

"Our contention is that people who want to talk at great length about extraordinary demand and depletion are making a serious mistakeellipseTechnology is increasing supply faster than demand can eat it up."

"People that talk about explosions in price, driven by demand and depletion-we just don't buy into that near-term," he said, adding that depletion would become a factor in 20-25 years.

Ties to gas markets

"Gas is another story," said Walker. "Gas is decoupling, to an extent, from oil.

If oil prices go into the single digits, the coupling mechanism will come back, says Walker. This is because-although most utilities that had the ability to switch to gas have already done so-if oil prices fall dramatically, suddenly gas becomes less competitive.

"Assuming this is a short-term aberration, and (oil prices) start moving back up, I think that gas is going to trade at a premium to its historic 6:1 relationship," said Walker. "It is right now, and I think it will continue to do that.

"So we're very constructive on gas. We believe that gas can be a very positive surprise for a lot of different reasons, many of which have come to light during recent events."

Copyright 1998 Oil & Gas Journal. All Rights Reserved.