Markets continue to be skeptic, shrugging of the OPEC move. Amid ever-worsening economic news, rising stockpiles and forecast that US oil consumption will be virtually flat for 20 years, oil markets on Wednesday sidestepped OPEC’s largest-ever single production cut of 2.2 million barrels a day. In the immediate aftermath of the announcement on Wednesday evening, oil fell below $40 a barrel for the first time in more than four years.
OPEC itself is to be blamed for this lack of response, for its past record in compliance has not been exemplary. OPEC members’ fractious relationships have made it difficult to control supply, and thus price, in both good times and bad, say Edward Chow, senior fellow at the Washington-based Center for Strategic and International Studies’ energy security program. “The experience in the last 20 years suggests that they will have a hard time” defending a price floor, he said, noting the group had similar problems when crude rocketed to nearly $150 a barrel in July. “They’ve been riding the roller coaster rather than managing supply,” Chow added.
A cut was very much round the corner, yet the question was ‘how severe’ that could be. There was though a definite element of surprise in the final announcement. Breaking from recent past, the cautious, conservative and yet the most influential OPEC player, Saudi Oil Minister Ali Al-Naimi showed his cards even before the meeting, telling the press there was already a consensus on 2 million bpd cut.
However, wrangling was still not over, as midway through the day, the OPEC President Chakib Khelil hinted that a production cut of 2.5 million also remained a possibility. The final decision of 2.2 million bpd lowering the group’s supply target to 24.845 million bpd, appears to be a compromise outcome.
Important non-OPEC members also have hinted to chip in. Russia cut oil exports by 350,000 bpd last month and may reduce supply a further 320,000 bpd next year, if prices remain weak, said Russian Deputy Prime Minister Igor Sechin during opening speeches at Oran in Algeria. Other non-OPEC producers, including Kazakhstan, may also trim its production, Sechin added. Azerbaijan may lower production by as much as 300,000 barrels a day, Azeri Energy Minister Natig Aliyev said in Oran.
The die was being cast since morning. As the OPEC ministers sat down in the meeting room, the mood behind the closed doors was definitely grim and gloomy.
The OPEC has not faced such a challenging environment since at least the 1980s. In the space of six months, the oil market has been turned on its head. Only some six months back, in June, some analysts were forecasting oil at $200 a barrel and companies were scouring the earth for new places to drill; now, no one really knows how low prices may fall. “It’s a classic — if extraordinarily dramatic — cycle,” said Daniel Yergin, chairman of Cambridge Energy Research Associates and author of “The Prize,” a history of the oil business. “Prices have come down so far and so fast, it’s become a shock to the supply system.”
The environment has changed drastically. During a stampeding bull market up to July this year, investors, rather speculators, were convinced that tight supply demand fundamentals could be exploited as they built up a large net-long-term position in crude oil futures from 2004 onward. Every scrap of geopolitical friction was seized upon to push prices higher — ranging from intractable conflicts in Nigeria and Iraq, to shorter term flashpoints of hijacked ships in the Gulf of Aden to the death of Pakistan’s Benazir Bhutto, all of which supposedly drew supply-demand fundamentals closer together.
But that was before the global financial meltdown. All of a sudden, banks were seen scrambling to ensure they did not become the next “nightmare on Wall Street” by cashing in positions to boost liquidity and realize capital gains. In the process, geopolitical risks ranging from Iranian threats to block the Strait of Hormuz, Russo-Georgian hostilities, “open war” declared by insurgents in the oil-rich Niger Delta, and even the hijacking of a Saudi Aramco super tanker in the Gulf of Aden, all failed to quell market decline. Such events merely six months ago would have made prices above $180 mark entirely conceivable.
Simple mathematics was not the OPEC way, too. The global oil demand is now set to contract for the first time since the early 80s. As per the Energy Information Agency of the US government, world oil demand will fall by 50,000 barrels per day in 2008 and 450,000 barrels per day next year, led by a 1.2 million bpd contraction in top consumer the United States this year and a further 200,000 bpd drop in 2009.
Besides, the OPEC also needed to “eliminate” an overhang of commercial oil inventories, which now stand at 57 days of supplies, down to 52 days. “We have five days of excessive stocks that could really lead to a collapse in prices,” the OPEC president reiterated justifying the ‘severe’ cut.
The Chinese dragon, the major driver behind the recent Bull Run in the crude markets, is in the meantime, also slowing down. Its oil imports in November hit the lowest level this year. There are also reports that China began filling its third strategic crude oil reserve last month.
About 7.3 million barrels of crude were pumped into the storage tanks at the Huangdao base, in Qingdao city on the east coast, adding to reserves built up last year at China’s first two reserve bases, sources monitoring shipments told Reuters. And the information supports what some analysts have suspected for months: that strong growth in China’s crude oil imports over recent months has been driven in part by stock building rather than demand from refiners, many of which have begun curtailing production as the Chinese economy slows and oil demand ebbs.
Compliance thus remains the word to watch! With the Kingdom currently producing at 8.2 million bpd against 9.7 million bpd in August and an implied output target of about 8.477 million bpd under existing OPEC curbs, Riyadh is surely emphasizing upon full compliance by other OPEC members too. That is important.
If OPEC can enforce the cuts it will have an impact on prices — but that’s a massive question mark at the moment.
OPEC president appeared confident in Oran that the group would do its utmost to ensure new restraints were strictly enforced. “I can tell you it’s going to be implemented and it’s going to be implemented very well because we do not have a choice,” said Khelil, also Algeria’s energy minister.
“If not, the situation is going to get worse.” And indeed one cannot contest this!
