Commodities: OPEC keeps tight grip on market

By Mark Goetz

When OPEC ministers meet in Vienna on 31 March, it will be to determine whether the “proactive” strategy they invoked during their 10 February meeting in Algiers has worked.

At the last OPEC ministers’ conference, member states decided to take immediate steps to eliminate around 1.5m barrels/day (bbl/d) of over-production from OPEC’s present production ceiling of 24.5m bbl/d. They also agreed to reduce production by a further 1m bbl/d as of 1 April to 23.5m bbl/d in order to forestall a perceived over supply of crude during the second quarter of 2004.

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According to the Saudi Arabian Oil Minister Ali Naimi, such action had to be taken in order to prevent OECD countries from replenishing crude inventories that might have had a damaging effect on prices during the second quarter. OPEC would loath to see crude prices fall as they did in the late 1990s, when the market was awash with crude.

Whether OPEC succeeds in removing its over-production from the market or not, at the time of writing Nymex crude prices are expected to remain in the lower mid $30/bbl range, and the OPEC basket is seen as continuing to average above $28/bbl.

When that decision was made, West Texas Intermediate (WTI) crude was selling in the neighbourhood of $34/bbl and Brent for around $30/bbl, while the OPEC basket had been above its $22-$28/bbl price range for weeks. Unofficially, and in accordance with a guideline that OPEC had set itself, if the OPEC basket price stays above $28/bbl for more than 20 days, OPEC should increase production in order to meet market demand and bring the basket average back within its price range. That guideline now appears to have fallen by the wayside, although OPEC ministers say that the group is working to keep the market in balance around a basket price average of $25/bbl.

By the end of March, OPEC should be able to tell if its members are adhering to quotas and if the expected decrease in demand for crude during the second quarter appears ready to set in. If demand is still strong and prices are at the levels they were in mid-February, then OPEC has said that it will reconsider the 1 April production cut. In a scenario that would be ideal for some, OPEC would produce at its current 24.5m bbl/d ceiling and the OPEC basket average would be around $25/bbl.

But the attractiveness of high crude prices make it difficult for OPEC members to reduce over-production, and many analysts are unconvinced that the group will be able to discipline itself. Furthermore, consumer countries have argued that OPEC has held crude supplies too tight in recent months to prevent them from rebuilding their depleted inventories, as they traditionally do at this time of year. But according to OPEC, large inventories and strategic petroleum reserves are factors that reduce its ability to influence crude prices, and therefore it would prefer to have consumer countries view OPEC as “the repository of the inventory”, as the Saudi oil minister put it.

Calls from consumers that further supply cutbacks will only serve to keep prices high have been dismissed by OPEC, which has argued that high crude prices are being influenced by factors other than market fundamentals. This shows that the market is well supplied with crude. Furthermore, OPEC has stated its opinion that the weak American dollar justifies high prices in that producing countries are earning less from their crude exports.

According to figures released by the Paris-based International Energy Agency (IEA) in mid-February, OPEC may be correct in its calculations on how much crude OPEC needs to supply the market during the second quarter of this year. In its February Oil Market Report the agency forecast an implied call on OPEC crude of 23.7m bbl/d during the second quarter, 2.5m bbl/d less than its estimated first quarter call of 26.2m bbl/d. Third quarter demand for OPEC crude is projected at 25.5m bbl/d and fourth quarter demand at 26.8m bbl/d.

OPEC estimates that some stock build has taken place during the first quarter and there will continue to be enough crude on the market for the second and third quarters to allow consumers to replenish stocks to some degree. But the plan calls for production to be kept at a level that will not allow the market to return to conditions seen during the late 1990s and first years of this decade.

As the world’s largest consumer of crude, the US was hardly pleased by OPEC’s announcement that it would remove oil from the market, as was Russia, which is currently competing with Saudi Arabia as the world’s largest oil producer at around 8m bbl/d.

After OPEC had announced its plans to remove 2.5m bbl/d from the market by early April, a White House spokesman said that the Bush administration would not comment on OPEC’s decision, but added that the administration hoped the oil producers would not take action that would hurt the US economy ” a development that could play havoc during a US presidential election year.

The Russians criticized the move and said that it planned to discuss the matter with OPEC ministers at their March meeting. “We don’t support the decision,” a Russian Energy Ministry official said, adding that OPEC had not discussed the move with Moscow and that it would cause a renewed climb in prices. Moscow is dedicated to maintaining a price level that is acceptable to both OPEC and non-OPEC producers, the official said.

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