As OPEC decided last Saturday to take time and weigh its options, before making its next move, taking cue the global crude markets took a deep plunge. Once the markets reopened after the OPEC decision, oil prices crashed by more than nine percent — touching the lowest level in almost three and a half years.
Amidst compelling signs of a global economic meltdown and with the National Bureau of Economic Research (NBER), regarded as the official historian of the US economy, confirming that the US economy was now in recession — declining instead of growing stronger — for almost a year now and Secretary Paulson conceding, “the journey ahead will continue to be a difficult one,’’ the US light crude for January delivery fell by almost $100 off the record $147.27 peak recorded on July 11.
And while the crude markets were literally in the midst of a bloodbath — in real sense — for the first time Saudi Arabia, the OPEC kingpin, gave a firm indication of what it meant by a fair price. While pundits have been venturing out with their perception of what could be a fair price to the producers as well as consumers, there has not been a single word from major players within the grouping in recent years.
Hence when none other than King Abdullah himself came out with the figure of $75 a barrel as a fair price for crude, it was significant to say the least. Although the royal pronouncement on the eve of OPEC informal meeting in Cairo got less attention than what it deserved as the world appeared engrossed with the OPEC output decision, the fact remains that this was the first time in recent years that someone as influential as Saudi Arabia from within OPEC gave an indication of what fair price meant to them.
Elaborating on the reasons for adopting the target of $75 a barrel as a fair price, industry veteran Minister Ali Al-Naimi reiterated in Cairo that oil prices needed to return to $75 to keep the more expensive new projects at the margins of world supply on track. “There is a good logic for $75 a barrel,” the minister underlined. “You know why? Because I believe $75 is the price for the marginal producer. If the world needs supply from all sources, we need to protect the price for them. I think $75 is a fair price.” Indeed there is logic behind the argument!
Although not every one, appeared to be approving the ‘price floor Riyadh was endeavoring for,’ with New Delhi and Tokyo already showing signs of disapproval, major Western capitals seem to have heaved a sigh of relief. The Saudi comments appear to at least confirm that OPEC, as a group, will not seek to push crude prices back toward $100 a barrel during a recession, analysts feel.
The OPEC decision to defer decision to its Dec. 17 Algeria meeting seem to have received mixed ratings. Many are starting now to question the ability of OPEC to act as a group and influence the markets significantly. Over the summer, the OPEC could not prevent oil prices from surging to record levels even when its members pumped full out. Now, the producers’ seem equally unable to stop prices from collapsing as the global economy cools down, some believe.
“The OPEC meeting last weekend shows you that there’s not a lot the group can do to stop the free-fall in oil prices,” said Phil Flynn, analyst for Alaron Trading in Chicago.
Others felt the delay in decision to cut output could prove costly. It has typically taken three to six months for oil prices to rise after OPEC trims supplies, a Deutsche Bank report underlined. “In terms of crude oil, we believe downward pressure on prices is likely to persist throughout next year,” according to a report by Deutsche Bank. “OPEC will struggle to cut production as fast as world growth is slowing over the next 12 months.”
“The longer OPEC waits to cut supplies, the higher stocks rise and the longer we think it’ll take for fundamentals to tighten once the tide does turn,” Jan Stuart, an economist with UBS in New York said in a report.
However, OPEC ministers had other considerations before taking a decision in haste to cut output. Over the last decade, OPEC has stepped in three times with large production cuts to stop prices from falling — in 2001, 2003 and 2006. Only once, however, did producers fully comply with their pledges to trim their output, according to analysts at Barclays. When prices last fell toward $50 a barrel, at the end of 2006, OPEC agreed to cuts totaling 1.7 million barrels per day but they could cut only 900,000 bpd, according to Barclays.
A Reuters survey suggested the OPEC compliance with the output constraint regimen was only 66 percent of the promised 1.5 million bpd in November. Supply from OPEC fell to 31.2 million bpd in November from 32.17 million bpd in October, the survey said.
The 11 members bound by output targets pumped 28.07 million bpd, down from 29.06 million bpd in October. That represents 66 percent compliance with OPEC’s pledge to lower supply by 1.5 million bpd from Nov. 1. And this again brings to fore the old, recurring issue of quota compliance within the group. OPEC has agreed to trim its output by two million bpd since September.
But is every one complying? It remains a billion dollar question. Reports indicate that in Cairo, Saudi Arabia and some other Gulf OPEC members hence insisted on tighter adherence to output restraints before making their next move. Saudi Oil Minister Ali Al-Naimi was quoted by Al-Hayat newspaper emphasizing that OPEC would not need to make a further cut in oil supply when it meets in Algeria if producers comply with previous curbs and fuel stocks decline. And this is a big if indeed in the current circumstances.
“We are concerned about overproduction,” said Qatari oil minister Abdullah Al-Attiyah. “Compliance I think is okay,” said Kuwaiti oil minister Mohammad Al-Olaim. “But the market conditions require us to be 100 percent compliant.”
There were definite fireworks at the Intercon in Cairo last Saturday. Some reports indicate that fingers were pointed at Iran and Venezuela, often regarded as hawk within the grouping, for not fully complying with the quota cuts. Petrologistics estimated last week that, based on shipping data, Iran’s production fell by 80,000 bpd in November, much less than the 199,000 bpd it was due to cut.
Estimates show Saudi Arabia and its Gulf neighbors making good their share of OPEC’s 2 million bpd of cuts since September. Data from Petrologistics estimated OPEC output losing 1.22 million bpd last month, with nearly half of that reduction shouldered by Saudi Arabia alone, though Riyadh is responsible for only about a third of output.
With the global oil demand set to contract and inventories continuing to swell, OPEC will have to show greater discipline within its ranks and, before trying to co-opt non-OPEC members such as Russia in its output restraint regimen, as some are endeavoring today, OPEC definitely needs to put its own house in order first. Is it too steep a price to pay for keeping a sway on the global crude markets?
