International Herald Tribune: OPEC’s tough call: Raise or hold oil supply

By Jad Mouawad
Monday, December 3, 2007

After a year of dizzying gains for energy markets, a rapid fall in oil prices lately is posing a dilemma for OPEC, the oil-producing cartel.

Should OPEC make industrialized countries happy by increasing the oil supply, a move that would probably send prices down further? Or should it keep production at a steady level at a time of economic turbulence, when demand could easily taper off?

As they prepare to meet in Abu Dhabi this week to set output levels for the winter, officials from the Organization of the Petroleum Exporting Countries are mindful of the many uncertainties that complicate their task. Oil prices flirted with $100 a barrel just two weeks ago, but fears of slowing economic growth have since pushed them down by more than 10 percent. Oil futures settled at $88.71 a barrel, down $2.30, on Friday, after their steepest weekly decline in more than two years.

This year, as the oil markets have grown more volatile and unpredictable, OPEC officials and energy analysts have noted an increasing disconnection between the price and supply of oil. They attribute the large price swings more to financial speculation than to market fundamentals, and say that the price surge in recent months seemed increasingly at odds with the outlook for the United States economy.

“There is absolutely ample supply,” Ali al-Naimi, Saudi Arabia’s oil minister, said Friday at an energy conference in Singapore. “The price movement has nothing to do with the fundamentals of the market.”

Saudi Arabia, the cartel’s de facto leader, is wary of increasing supplies this winter. At the conference, Naimi repeated his view that there was a “mismatch” between today’s high prices and oil supplies. “Anyone that tells you otherwise is wrong,” he said.

OPEC members are worried that today’s sky-high prices have the potential to reduce consumption. But the members are also unsure whether they need to raise their output, since doing so at a time when the economy slows might hasten a sharp price drop, which is what producers fear most.

“The economic situation has finally dawned on the energy markets,” said John Kilduff, an energy analyst at MF Global, a brokerage of exchange-traded futures and options. “OPEC is right to be concerned about falling into a production trap if they respond too aggressively.”

One option that will be discussed at Wednesday’s meeting is a possible increase of 500,000 barrels a day in the group’s overall output, which now stands at about 30.6 million barrels a day. Some OPEC members, including Nigeria, have voiced support for such a move, but Saudi Arabia would probably not back it.

“It’s a very fine line they are trying to tread,” said David Kirsch, an analyst at PFC Energy, a consulting firm in Washington. “They really have to be concerned about the downside risks to the market. The big fall in prices really took a big production increase off the table. It confirmed that the fundamentals do not support high prices.”

Yet OPEC could still be forced to act, particularly if oil prices rebounded sharply in the days ahead of the meeting. Among the wild cards are renewed tensions in Northern Iraq between Turkey and Kurdish separatists, and Iran’s tough stance on its nuclear program.

As a group, OPEC’s 13 members account for 40 percent of the world’s daily oil exports, making them the only producers capable of raising their output in a meaningful manner. Together, they now have about 2.5 million barrels a day of spare capacity, according to analyst estimates, mostly in Saudi Arabia. This gives the Saudi kingdom, the world’s top oil exporter, the most clout to set the tone within OPEC.

Some OPEC insiders are particularly concerned about the risks associated with slowing demand next year, especially following the credit and housing market crisis in the United States, which consumes roughly a quarter of the world’s oil. Globally, oil demand is expected to grow between 1.5 million and 2 million barrels a day next year.

At the same time, new supplies are slowly making their way on the market. New oil and natural-gas liquid production from OPEC nations could reach 2 million barrels a day next year, and another 1.1 million barrels a day are expected to come from non-OPEC sources, like Russia or Norway, according to estimates by Deutsche Bank. Some OPEC specialists say these factors could substantially alter the balance between supply and demand after years of market tightness.

At a recent meeting in Riyadh, OPEC leaders cited a variety of reasons for the spike in oil prices. Those included a weak dollar, refining shortfalls in the United States, runaway demand in Asia and speculative investments in commodities.

Abdalla Salem el-Badri, OPEC’s secretary general, said that oil producers were not happy with current prices because they might lead to lower demand in the long term.

“We know what high oil prices mean for us,” Badri said in a recent interview. “We really have no interest in high oil prices. And we really have no interest in low oil prices. We want stable prices.”

But he indicated that OPEC was not in a rush to increase supplies until bottlenecks in the refining industry, especially in the United States, were resolved.

“We will add more oil if we know oil will go to the refineries, but we won’t add if they go to commercial stocks,” Badri said, referring to longer-term inventories of oil.

The meeting last month in Riyadh among OPEC’s heads of states also highlighted new signs of tension within the organization. Some countries, led by traditional price hawks like Iran and Venezuela, said they considered current price levels as fair. They criticized the dollar’s weakness and suggested that OPEC should uncouple the price of oil from the United States dollar.

The weakening value of the dollar, which erodes the purchasing power of oil producers, means that OPEC has fewer incentives to seek lower oil prices. On Friday, the euro was at $1.4677 after touching $1.4967 recently, the unified European currency’s strongest level since its debut in 1999.

“A weaker dollar means that OPEC is likely to be more aggressive in its pursuit of higher rather than lower prices,” Frédéric Lasserre, the head of commodity research at Société Générale in Paris, said in a recent report.

Industrialized nations would like to see OPEC increase its output. Nobuo Tanaka, the executive director of the International Energy Agency, which represents 26 oil-consuming nations, said, “The current price level is sending a message to producers: We would wish for some additional barrels sooner rather than later.”

Since 2000, OPEC’s policy has been to fine-tune its supplies to align closely with oil demand but without allowing oil companies and refiners to build too many oil inventories. That policy of careful management has helped the cartel raise prices following the oil collapse of the late 1990s.

But the policy isn’t foolproof. The last time OPEC tried to act to push prices down, it had little impact. After its last meeting, in September, OPEC members agreed to increase production by 500,000 barrels a day. That measure failed to curb prices.

“The high level of disagreement and potential tension shown at the previous output discussions in September suggests that there is absolutely nothing cut-and-dried about the forthcoming negotiations,” Barclays Capital said in a research note last week.

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