OPEC Approves Cut to Output by 1 Million Barrels

October 11, 2006 at 11:36 pm (Economics, US)

 

Bad news for everyone, except OPEC members. Remind us oil crisis in the middle of the 1970s, when OPEC cut its production.

 

From New York Times

 

After a week of informal talks, the president of OPEC, Edmund Daukoru, said today that the oil cartel had agreed to trim production by 1 million barrels a day, although the group’s members are still negotiating over how the cut will be divided among them.

But the confusion surrounding OPEC’s position and the group’s inability to reach a formal agreement quickly sent oil prices to their lowest level this year. Some OPEC members are calling for an emergency meeting next week to formalize the deal, which is still not official.

Investors were unimpressed. The benchmark contract for light, low sulfur crude fell 1.5 percent on the New York Mercantile Exchange to trade at $57.65 a barrel this afternoon, the lowest since February, erasing small gains from earlier in the day. Market analysts said that a report from the International Energy Agency, forecasting slightly lower demand for oil than anticipated in 2007 because of slower growth in the United States, weighed much more heavily on the market than the OPEC announcement.

 

As the price of oil has fallen by nearly 25 percent since peaking in mid-July, OPEC members have so far been unable to agree on a common approach to reducing supply and sustaining prices. That has left oil markets around the globe unsettled.

The prospect of OPEC agreeing to act in concert to keep prices from falling further led the United States energy secretary, Samuel Bodman, to say today that he is seeking talks with the cartel in the next week. “We have continued to encourage OPEC, as well as all producers, to make plenty of oil available, so we can keep our market well-supplied,” Mr. Bodman said in an interview with CNBC.

This is the time OPEC should have been bracing itself for — the first quota cut in two years. Instead, as an analyst from Société Générale noted, “OPEC failed its return to discipline.”

The Organization of the Petroleum Exporting Countries is not a homogenous group, but a collection of countries with divergent political and economic interests. As oil prices more than doubled over the last three years, OPEC members found it easy to agree on a common policy that brought them windfall revenue.

But with prices now falling, that consensus is fraying. Iran and Venezuela have called for a special meeting in Vienna next week to endorse production cuts. Others, like Kuwait and Algeria, have backed the proposal but disagree on how to apportion the cuts. And Nigeria has resisted calls for a special meeting next week, to avoid overshadowing OPEC’s next scheduled conference, to be held in Abuja, the Nigerian capital, in December.

The group’s most influential member, Saudi Arabia, has remained conspicuously silent. The Saudis are understood to support a production cut, but OPEC watchers reason that the country, which accounts for one-third of OPEC’s output, wants to be discreet, with midterm elections in the United States just a few weeks away.

With bickering in the ranks and without clear leadership from Saudi Arabia, analysts are left weighing vague signs to discern what OPEC is up to.

Paul Horsnell of Barclays Capital said, “The Kremlinology of OPEC is back.”

In the last two years, OPEC producers have been steadily increasing their output to meet rising demand for oil and to make up for unexpected shortages in global supplies. That has led the group to raise its total output above 30 million barrels a day, the highest level in more than 25 years.

Now, with supplies aplenty, inventories brimming and demand slowing, OPEC finds itself having to shift its focus to manage a declining price pattern, reducing its production to keep world prices above certain levels.

Because OPEC has not formally reduced its ceiling on output since April 2004, any talk of how to divide the lower production is certain to lead to acrimonious negotiations as countries fight to keep their market share. One option being discussed is to reduce the group’s actual production by a million barrels a day while using the current quotas to calculate each country’s contribution.

Because some producers have been paring their output in recent months, OPEC now produces 27.5 million to 27.8 million barrels a day, depending on estimates. That excludes oil from Iraq, which has no production quota.

Referring to OPEC, Sadek Boussena, a former president of the group and a former oil minister from Algeria, said: “They have had no training for nearly two years. It’s like a football game. Right now, they are warming up for a friendly game. But if prices fall further, it might become vital for them to act.”

OPEC did away with its quotas last year when its members pumped at maximum capacity, but its effectiveness as a cartel comes from allocating output targets to its members and sticking to them.

In the past, quota compliance has proved notoriously difficult, as renegade members would regularly disregard their allocations while pretending to adhere to OPEC agreements.

In the 1980’s, widespread quota violations led to a production war initiated by Saudi Arabia — which basically opened its spigots and flooded the market with oil, leading to a price collapse — to bring recalcitrant members back into line. That is an experience no one in the organization wants to see happen again.

After years of low prices, producers have gotten used to today’s higher prices. They need the higher revenue to finance their booming economies, their huge investments in energy projects and in real estate. Arab gulf countries, led by Saudi Arabia, will spend an estimated $700 billion by 2010, according to the latest report on the region by the International Monetary Fund.

“After two years of free-for-all production, going back to quotas is difficult,” said Manouchehr Takin, an energy analyst at the Center for Global Energy Studies in London. “But they know that if they don’t get back their discipline quickly, if they don’t control the leakage and the cheating, they can lose the market.”

Some countries — including Algeria, Libya and Qatar — are producing way above their nominal quotas and will resist calls to return to the old allocations and give up some of their market share.

For example, Algeria produces 1.4 million barrels a day and aims to raise its capacity to 2 million barrels in coming years. Yet its quota is 894,000 barrels.

From a quite different perspective, Iran, Nigeria, Venezuela and Indonesia are having trouble meeting their quotas but will be loath to give up their allocations.

Venezuela’s production slumped after a devastating strike by oil workers late in 2002 and the country has since found it tough to increase its output to more than 2.5 million barrels a day. Yet it still has a quota of 3.2 million barrels.

And Indonesia, which has a quota of 1.45 million barrels but pumps only 860,000 barrels, too little for its own domestic consumption, has become a net importer of oil.

So deciding where the new quotas should stand will be a real challenge, and OPEC’s ministers studiously avoided the topic for the last two years. But analysts say that the organization cannot put off the discussion any longer.

“Pandora’s box has been opened,” Frédéric Lasserre of Société Générale said.

 

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