When the price of oil soared past $100 a barrel and then over $140 earlier this year, it was way too high. But having gone too far one way, the pendulum has swung too far the other. That was why Saudi Arabia was fully behind OPEC’s decision on Wednesday to cut oil production by 2.2 million barrels a day. In normal market conditions where prices are controlled by supply and demand, the cut, OPEC’s largest ever, should have worked. Disappointingly, it has not — so far. The price has continued to fall, dropping yesterday below $40. Maybe the slide would have been even worse if no action had been taken.
There will be voices that say a couple of days are far too soon to see results from the cut. On one level, that is true. The figures on stocks held, particularly US inventories, may look very different in a month’s time that will be the middle of winter in the Northern Hemisphere. By then too, the expected natural downturn in production in Russia, the world’s second largest exporter, by up to 400,000 barrels a day next year, will have started to knock in. On the other hand, the recession may look even worse in January. That would more than counter any delayed effect of the cut and push oil prices even lower.
The fact is that if the OPEC cut were going to influence the market, it should have done so immediately. It did not for a number of reasons. One is that the market thinks it is not enough — by a long shot. With inventories full to overflowing and demand unlikely to rise till the spring at the earliest, the view is the cut should have been far bigger — as much as five million barrels a day. That would have been difficult to achieve. For all producers, this is an uncomfortable time. For a few, it is a particularly painful one. Major cuts in exports when the price is less than what they based their budgets on is an economic nightmare for them. That is where the market’s other worry — compliance — comes in. It is apparent that there is considerable skepticism whether all OPEC members will stick to the agreement reached in Oran, Algeria. They have to. If they do not, it could destroy the organization’s credibility. But if they do, the cuts may still yet work. Everything must be done to ensure that all members stick to what they have agreed.
There is a bigger problem, though. The unfortunate truth is that governments can no more shore up the price of oil than they can shore up the world’s stock markets. If President George W. Bush, Prime Minister Gordon Brown, President Nicolas Sarkozy and so many other world leaders cannot ensure market stability by throwing trillions of dollars at it, why should anyone expect oil producers to do any better? The fact is, and it was seen when oil prices rocketed, it is not market forces that control them any more, it is ignorant and incompetent greed. The same economically illiterate dealers who previously thought that the appetite for oil, particularly in China and India, was insatiable and who in their wild enthusiasm for oil never bothered to examine the facts about demand in such economies now only see unlimited recession ahead. Market realities do not come into it. One last point is that oil at current prices is not good for the oil industry either. Most new oil, and there is a great deal but it is all either offshore or nonconventional, is extremely expensive to extract. The Athabasca oil sands in Canada (now the biggest supplier of oil to the US) requires a price of at least $50 a barrel to be profitable; the newly discovered underwater fields off Brazil require $70 a barrel. Oil at unrealistic low prices threatens future supplies. It can only result in future market turmoil.
