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Surprise Opec output cut boosts oil price

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Surprise Opec output cut boosts oil price

By Carola Hoyos in Vienna

Published: September 10 2008 02:40 | Last updated: September 10 2008 08:41

Crude oil prices climbed back over the critical $100 level after Opec on Wednesday surprised the oil markets by announcing that it would make a small but symbolic reduction in its output because the oil cartel views the market as oversupplied.

Traders had been betting the group, which controls about 40 per cent of world oil production, would maintain status quo, and at best make gradual unannounced reductions in its production.

Instead, Opec, after a five hour session in Vienna, agreed to abide by the production limit it had set for its members in September 2007. This would reduce the group’s production by 520,000 barrels per day over the next 40 days.

If all members adhered to the cut, Opec production would fall back to 28.8m barrels per day.

The price of Brent crude, the European benchmark, jumped $1.65 to $101.99, rising from a five-month low of $98.89 on Tuesday. West Texas Intermediate, the US benchmark, rose 64 cents to $103.90.

Since jumping to an all-time high of $147.27 in July, the combination of the slowdown in the global economy, which is damping oil demand, and higher production from the Opec oil cartel has brought down oil prices 30 per cent.

Opec said that oil prices had dropped significantly in recent weeks driven by lower demand especially in developed countries, increased oil supply, the strengthening of the US dollar, and easing of geopolitical tensions,.

“All the foregoing indicates a shift in market sentiment causing downside risks to the global oil market outlook,” Opec said in a statement.

The strengthening of the US dollar against the euro and sterling is providing a cushion to Opec countries as it means that the barrel’s purchasing power in the eurozone and the UK remains strong.

The issue of whether to include a call for Opec members to abide by their quotas, which they had brushed aside when oil prices surged in July, was hotly debated in the longer-than-usual closed-door meeting. Iran and Venezuela had earlier in the week called for production cuts, but others had been less enthusiastic, fearing such a move would worsen the problem of demand erosion.

One of the few analysts that called the meeting’s outcome correctly was Washington-based PFC Energy, which yesterday anticipated a 500,000 barrel a day cut. In a note it said: ”The communique text will likely focus on the need to abide by agreed-upon production targets rather than on numerical targets for cuts.”

Now Opec has the tough task of abiding by what it has agreed. The lion share of the cutback will have to come from Saudi Arabia, which boosted its production unilaterally in July when prices were high. If the group does not now attain at least some of the announced cutbacks, it risks losing credibility in the market and exasperating the price drop as traders bet on the cartel’s powerlessness.

The cut came as a surprise after Ali Naimi, Saudi oil minister, signalled that he was comfortable with the current supply and demand outlook.

“The market is fairly well balanced and we have worked very hard since June’s meeting to bring prices to where they are now,” he said before the meeting, which was held overnight because of the Ramadan fasting.

Another Saudi official made clear high prices were not necessarily in the kingdom’s favour. As prices surged this year, Riyadh grew concerned about demand destruction, especially in the US, Europe and Japan. It was one reason the kingdom increased output unilaterally to the highest in more than 25 years.

Sentiment among Opec ministers has clearly shifted from feeling unable to pump enough oil to stop runaway prices to concern that supply is already or is about to outstrip demand as world economies sputter.

Michael Wittner, head of oil research at Société Générale, said the cartel might have already begun this month to trim its output, pointing to “recent weakness in tanker freight rates”.

Igor Sechin, Russia’s vice-premier, called for closer co-operation between Opec and his country in a further sign of Moscow’s determination to flex its muscle in energy markets.

Mr Sechin, the most senior official from Russia to have attended an Opec meeting in recent history, called for the two to more closely work together ”to provide for a stable pricing environment.”

Russia is an observer member of Opec, meaning it attends meetings but is excluded from the quota system and policy decisions. The last time Russia cut its output in solidarity with Opec was in 1999, when Mexico and Norway also reduced their production to help boost prices that had fallen to 9 dollars a barrel.

But today prices are far beyond that point and Russian relations with Europe and the US are strained, with Washington increasingly concerned about the Kremlin’s willingness to brandish its oil and gas production as a diplomatic weapon.

This latest declaration is likely to add to that concern, even though Opec has recently held a relatively benign position and become a reliable supplier of oil to the world for more than two decades.

Opec also officially suspended Indonesia’s full membership to the group.

 

EDITOR’S CHOICE

In depth: Oil – Aug-12

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