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OPEC Plans Drastic Cut In Oil Production

Washington Post

Flags of Organization of the Petroleum Exporting Countries members fly in Oran, Algeria, site of tomorrow's meeting.

Flags of Organization of the Petroleum Exporting Countries members fly in Oran, Algeria, site of tomorrow’s meeting. (By Adam Berry — Bloomberg News)


Washington Post Staff Writer 
Tuesday, December 16, 2008; Page D01 

Facing its biggest test in a decade, the Organization of the Petroleum Exporting Countries is planning to make a major cut in oil output at a meeting in Oran, Algeria, tomorrow in an effort to stop the slide in oil prices, which have dropped by two-thirds since July.

Confronted by sputtering world oil demand, the cartel is expected to make production cuts of about 2 million barrels a day to reduce the size of world inventories and to boost prices back up to the $75-a-barrel level that Saudi King Abdullah has called reasonable. It will be the group’s fourth meeting in four months as it tries to adjust to the weakening world economy.

“They are going to cut and they are going to cut big,” said Roger Diwan, a partner at PFC Energy, a Washington consulting firm. Even after substantial OPEC output cuts earlier in the fall, world oil inventories “are building much faster than people thought,” Diwan added. Oil stocks are big enough to cover 57 days of supplies, up from the five-year average of 52 days.

Reaching the $75-a-barrel price target could be a tough task, however. U.S. oil demand has been weaker than any time since the economic slowdown that followed the Sept. 11, 2001, attacks on theWorld Trade Center and Pentagon. Even though retail gasoline prices have plunged to a nationwide average of $1.66 a gallon for regular, cash-strapped motorists continue to use less fuel than they did a year ago. The Energy Information Administration is forecasting a 3.4 percent drop in motor fuel use for 2008, and a bigger drop in oil-based motor fuel after taking rising ethanol use into account.

Meanwhile, Chinese oil demand, assumed to be a reliable engine of growth, might have dropped in November for the first time in three years, preliminary data suggest. The International Energy Agency recently said that worldwide oil demand would fall for the first time since 1983 to 85.8 million barrels a day.

Oil prices closed yesterday at just $44.51 a barrel on the New York Mercantile Exchange, down $1.77 from Friday despite anticipation of OPEC cuts.

Saudi Arabia, which is currently producing about 8.6 million barrels of oil a day, will bear the brunt of the production cuts, as usual, analysts said. That would bring the kingdom’s production down to the lowest levels since the late 1990s, when prices crashed to about $10 a barrel in the wake of the Asian financial crisis. The kingdom produced about 7.5 million barrels a day in the late 1990s.

This week, the Saudis will press other countries to join in the cutbacks. The Gulf Arab states such as Kuwait and the United Arab Emirates are expected to join in the production cuts.

OPEC currently produces about 40 percent of the world’s oil. On Oct. 24, it announced a 1.5 million-barrel-a-day reduction in output.

The precipitous drop in oil prices has had a dramatic impact on the fortunes of OPEC members, particularly on populous, big-spending countries such as Iran and Venezuela. “Most of these countries are running welfare states financed by oil,” said Fadel Gheit, oil analyst with Oppenheimer & Co. “The party’s over.”

It has also prompted a sudden reevaluation of capital spending projects. Royal Dutch Shell has announced that it will delay some of its planned expansion of expensive oil sands projects in Canada. Rob J. Routs, executive director of oil products and chemicals and a member of the board at Royal Dutch Shell, said that reaching the target of 700,000 barrels a day would be “pushed out at least two to four years.”

Gheit forecasts that the biggest oil and gas companies will trim capital spending in North America by 10 percent in 2009 and that smaller firms could trim spending plans by as much as 30 percent to protect cash flows. He said some companies were paying a 17 percent penalty to get out of contracts with companies providing drilling rigs.

“We are already putting down the seeds for a new oil spike,” Gheit said, noting that the drop in exploration and development spending would mean lower production capacity in the years to come.

For now, however, OPEC is worried about too much capacity and it is hoping that non-OPEC countries will also lower production, whether by design or neglect. Russia will probably send an observer to the OPEC meeting, but analysts say that Russia’s production will fall by about a half-million barrels a day next year because of natural field decline and inadequate capital spending by state-owned firms.

Oil prices have also come under pressure since July because financial institutions that had been driving much of the oil trading volume earlier in the year have been pulling cash out of the market to meet pressing liquidity needs because of the credit crunch, oil executives say. Outstanding oil futures contracts, known as open interest, fell 23 percent, according to Bloomberg News.

Prices have been falling over the past five months “because of a combination of the end of the financial bubble and supply and demand,” said Routs, the Shell executive. “Banks needed to look for liquidity, and fast.”

One sign of the changing attitudes on Wall Streetwas the recently revised forecasts of Goldman Sachs, which earlier this year predicted that prices would remain very high. In early May, Goldman Sachs analysts said oil prices could average $141 a barrel during the second half of the year.

But last week, the Goldman Sachs analysts issued a new forecast, predicting that oil prices will average about $35 a barrel during the first half of 2009. The firm’s forecast for all of 2009 was lowered to $45 a barrel from the most recent forecast of $75 a barrel.

“We think that the sharp and sudden collapse in global oil demand exceeds OPEC’s ability to, on its own, balance markets, and necessitates sharply lower non-OPEC crude oil supply,” the new report said.

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