OPEC cut yields no immediate effect

The decision by OPEC ministers to cut production by 1.5 million b/d effective Nov. 1 from the official quota of 28.8 million b/d had no immediate effect on plummeting crude prices.

Sam Fletcher
Senior Writer

The decision by ministers of the Organization of Petroleum Exporting Countries to cut production by 1.5 million b/d effective Nov. 1 from the official quota of 28.8 million b/d had no immediate effect on plummeting crude prices.

After OPEC's short meeting Oct. 24, front-month crude contracts fell to $62.65/bbl in intraday trading in New York and $61/bbl in London—the lowest levels in either market since May 2007. The December contract for benchmark US light, sweet crudes closed at $64.15/bbl, down $3.69 for the day on the New York Mercantile Exchange. In London, the November IPE contract for North Sea Brent was down $3.87 to $62.05/bbl.

Although traders were expecting OPEC to reduce output by 1-2 million b/d, crude prices were in steep decline for 2 days prior to the meeting. Over the last 3 months, crude has fallen almost 57% from record highs above $147/bbl.

It has been "a dramatic collapse unprecedented in speed and magnitude" to levels that "may put at jeopardy many existing oil projects and lead to the cancellation or delay of others, possibly resulting in a medium-term supply shortage," said OPEC ministers.

Olivier Jakob at Petromatrix, Zug, Switzerland said, "The current situation of economic slowdown and credit freeze is quite unique as together with low oil prices it will translate in an additional supply challenge in a year or two from now as some supply projects will be pushed further back."

Recession outweighs OPEC
General expectations of falling demand for energy through 2009 as a result of a deepening international financial crisis are influencing oil markets far more than OPEC's willingness to reduce supplies.

Fear of recession resulted in a steep liquidation of equity holdings in global markets Oct. 24, with the Dow Jones Industrial Average dropping 3.6% that day to end the week 5.3% lower than it started.

Recent strengthening of the US dollar against the euro and pound also has undercut energy prices. Oliver said, "Six months ago OPEC was complaining about the weak dollar, but it will start soon to regret these times."

He said, "OPEC is looking to shut down production because prices are too low for their economics. This makes an environment of spare production capacity where a return to previous record high prices will not be reached in the immediate future but where the supply side will get reduced at $50/bbl in a mirror image of the demand side getting reduced at $150/bbl." He said, "We remain of the opinion that $50/bbl would be on a medium term horizon as unsustainable as $150/bbl."

The lower the price of oil, the more likely are some OPEC members to over-produce their quotas to maximize revenues. In its latest monthly report, OPEC said its member countries produced 32 million b/d in September.

"OPEC Pres. Chakib Khelil stated the cartel wants to stabilize prices between $70-90/bbl, but it remains an open question whether this cut will be sufficient to offset demand weakness and, secondly, what the degree of enforcement will be," said Raymond James analysts. "Skepticism remains about OPEC's ability to offset deteriorating demand with oil trading down over $4.50/bbl despite the announcement."

Saudi projects pending
Analysts at Friedman, Billings, Ramsey & Co. Inc. (FBR) in Arlington, Va., said, "While it is possible that Saudi Arabia and the other producers can meet this [reduction] target, we would expect some of the cartel members to defect and exceed prescribed volumes if prices continue their slide, particularly given the size of quota cuts borne by Venezuela and Iran."

Despite the proposed cutback, FBR analysts said, "Saudi Aramco will proceed with plans for 100,000 b/d of new production from Dammam field, under the eastern Saudi city of Dhahran, in 2012." They said, "OPEC production cuts (and subsequent discipline in holding to quotas) are unlikely to halt Saudi Arabia's expansion projects already under way, including the 1.2 million b/d al-Khoreis project, as state-owned and private producers are likely to need revenue in the coming years, but delays are certainly likely."

Meanwhile, Jakob noted, "Medium to small E&P companies have started to be hurt by the credit crunch and are now starting to be hurt by limited cash flows linked to the lower oil prices." The reality, he said, "is that below $60/bbl there will be a flattening of the non-OPEC production curve, but that will be seen through the course of 2009 rather than in the remainder of 2008."

As has happened repeatedly during the oil industry's boom-and-bust history, lower prices eventually will reduce supplies and increase demand.

(Online Oct. 27, 2008; author's e-mail: samf@ogjonline.com)

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