OPEC's Big Move: Less Than Meets the Eye

With oil production outpacing consumption, the oil cartel votes to slash production by 4.2 million barrels a day. Will it make a difference?

OPEC's announcement at its meeting on Dec. 17 in Oran, Algeria, that it would cut 4.2 million barrels per day from September production levels sounds like a big deal. But it is less than meets the eye. That number includes 2 million barrels of previously announced cuts. If implemented, the measure would amount to around an 8% cut from current levels. Markets were not impressed, even though this represents the most serious OPEC tightening effort since the late 1990s. Prices for U.S. light, sweet crude fell $3.54 per barrel, to $40.06 per barrel.

OPEC itself has modest expectations. The idea is to begin soaking up excess oil. One delegate said it was highly unlikely that prices would move above $55 per barrel through the first half of 2009. Delegates think OPEC may well have to cut more next year.

OPEC is scrambling to catch up with a radically changed world. Thanks to an imploding world economy, demand for oil is expected by many analysts to fall this year for the first time in a quarter-century. Oil production is easily outpacing consumption as evidenced by the growing fleet of supertankers being used for floating storage. One industry source estimated there are roughly 21 such tankers carrying about 40 million barrels of crude steaming the world's seas today as opposed to just four or five at the end of October.

Plenty of Worries

OPEC is fearful the imbalance of supply over demand will accelerate next year if nothing is done. The oil ministers well remember that prices dipped below $10 per barrel as recently as the late 1990s. The organization is also worried about its almost complete lack of sway over the markets. Prices have fallen close to $100 per barrel since mid-July, even though OPEC held four meetings to manage the markets.

OPEC was clearly determined to make a big show of unity at its meeting, which was held in Algeria to honor Chekib Khelil, the Algerian minister of energy, who has served as OPEC's president this year. Even non-OPEC producers were invited to participate. Russian Vice Premier Igor Sechin brought a heavyweight delegation of the country's top oil chiefs. He promised that Russia would cut 320,000 barrels per day in 2009 if market conditions demanded such a move.

OPEC meetings are closed to journalists, but delegates wandering in and out of the meeting at the Oran Sheraton, a massive building perched on a hill above the faded port city, shared their views of the proceedings. The main issue was not whether to make a big cut. Even the Saudis, the most moderate player and leader, called for 2 million barrels a day of cutbacks from the beginning. Instead, there was disagreement over how to describe the cuts and where to draw the baseline. Venezuela, in particular, says it is producing more than most analysts estimate. Calling for cuts from September levels was a way of fudging the issue. But that obfuscation raises questions about the degree to which OPEC members will comply with the decision. Through November, OPEC had dropped production by about 1.2 million barrels per day from September levels. Nearly all of this came from Saudi Arabia, which has eased back production to about 8.5 million barrels per day, since reaching close to 9.7 million barrels per day last summer.

Market participants will now closely monitor compliance with the latest promised cuts. Having reduced production by 1.2 million barrels per day, the Saudis are unlikely to cut another 2 million barrels per day on their own. With several hundred billion dollars in the bank and a relatively small population, they can tolerate prices at today's levels much longer than big-spending Venezuela and Iran. The Saudis want to see those countries, which are the two largest OPEC producers after the kingdom, take more of the pain. The new agreement "reflects a de facto reallocation of quotas," says David Kirsch, an analyst at PFC Energy in Washington. "In September several members were underproducing their formal quotas, so they are looking for real cuts from these members," he adds. If those cuts don't materialize, dissension in the producers' club will increase, putting more downward pressure on prices.

Business Exchange related topics:Oil and GasOil PricesGlobal Economy

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