THE decision yesterday by the OPEC oil ministers meeting in Isfahan to raise output by half-a-million barrels — to 27.5 million barrels a day with a further half million agreed if the current high oil price does not stabilize in the second quarter — is as welcome as it is wise. While the current economic strength of the Kingdom has been underpinned by strong oil prices, it is in nobody’s interests to have oil costs hit such a level that growth worldwide is affected. Oil Minister Ali Al-Naimi echoed the sentiments of other OPEC ministers when he said that he wanted to see the price of a stabilized between $40 and $50.
The economic truth is, however, that the world has changed a great deal over the last 20 years. It is no longer simply supply and physical demand that dictate the oil price. The forward market in oil is highly liquid and sophisticated and is no longer confined to end-users. Investors have seized the opportunity to pour billions of dollars into buying up oil, anticipating that continued Chinese economic growth — which is the principal driver of the present increased demand — will continue to push prices higher. Two things could unhinge this investment strategy. The first would be if the Chinese economy suffered a major setback. The second would be if the high cost of oil reduced economic growth outside China to a crawl. In such circumstances, even the vibrant Chinese economy would be hard-pressed to sustain itself if its export markets collapsed.
Because of the presence of so many financial investors in the market, the price is being driven upward on the expectation that the price will continue to rise. The International Energy Agency is looking to a fourth quarter demand of 86.1 million barrels a day, up from the average of 83.7 million barrels for the first nine months of this year. As more people pile in, so the price will climb until it no longer bears any relationship to the market fundamentals — at which point there could be a dangerous and far-reaching collapse.
OPEC yesterday did what it could to inject stability into the market so that when adjustments come, they will be manageable and have the minimum impact on the wider economic picture. The hope is that lower spring and summer consumption will enable consumers to build up sufficient stocks to avoid a further battle for supply in the autumn. The question is whether prices will ease sufficiently during this stock-building season. Any significant reduction is likely to bring a new rush of buyers which could push the price right back up again.
OPEC has done its part to try and dampen the market. Its next meeting in June may be equally important in terms of further increases in supply. However, OPEC is no longer the main arbiter of price. If the current bull oil market turns bearish with far-reaching consequences, not simply for overambitious investors but for world economic prospects, it will not be because of OPEC. In the present circumstances the organization has done all that it reasonably can to encourage a return of stability to the market.
