Good for OPEC, Bad for the Recovery?

With the cartel's decision not to hike output, consuming nations trying to break out of the slump have another reason to worry

Burned by low oil prices in recent months, OPEC oil ministers are of a mind to make up for lost opportunity. At their meeting on Mar. 15 in Vienna, they decided against loosening production restrictions that have helped to drive prices to more than $24 per barrel -- the highest level in six months.

OPEC delegates justified their decision by saying it's still too early to tell whether a global economic recovery is under way that would justify opening the spigot a little more. They also cited heightened tensions in the Middle East -- the threat of a U.S. attack on Iraq and all-out violence between Israelis and Palestinians -- as reasons for keeping the price high.

One Arab delegate estimates that the possibility of an American attack on Iraq is boosting prices by $2 to $3 per barrel. "We think the fundamentals are there for a balanced market," he says. "There's no need to do anything now."


  Consuming nations across the world have reason to worry, however. Prices could well move even higher if increasing demand, spurred by the world recovery, further drains inventories. Refiners will soon start stocking up for the high-consumption summer driving season. That could rapidly drain inventories of crude, which are already low. Some analysts think higher prices over the next several months are almost a given now. "The price is going to go up," says Gary N. Ross, CEO of New York-based energy consultants PIRA group.

Rising energy costs could well crimp the economic recovery, especially in oil-dependent countries in Asia where energy costs account for a larger percentage of gross domestic product than in the U.S. or Europe. What's more, OPEC has a history of never catching the economic cycle quite right. "They never cut enough when demand is falling, and they never add enough when demand is rising," Ross says.

On the plus side, OPEC ministers are laying the groundwork for a production increase at their next meeting, now scheduled for June, if current trends hold. And Saudi Oil Minister Ali Al-Naimi said the cartel might move more quickly if inventories look dangerously low.


  Analysts think prices could rise to as high as $30 per barrel in the next few months, but they doubt that such a level will be sustained. Nowadays, there's far more spare capacity than there was in 2000, when world consumption was very close to total oil output. OPEC has trimmed overall production by some 5 million barrels per day since November, 2000. Compliance with these quotas is running about 80%, analysts say.

One OPEC official estimates that there's at least 6 million barrels of spare capacity in the world. Managing the markets is not an easy task. Data on crude stocks and production are sketchy, especially outside of the U.S. In addition, OPEC has to deal with Iraq, a member not included in the quota agreements, whose daily exports fluctuate between zero and close to 3 million barrels, depending on Saddam Hussein's mood and Iraq's battles with the U.N. sanctions regime.

All in all, OPEC has done a better-than-usual job in the last two years. The organization avoided sharp price drops into the $10-a-barrel range that marked the bottom of past recessionary cycles. Analysts say the organization is more cohesive and even more professional than it was in the past. Among the factors credited for the change is the accord between Saudi Arabia and Iran on setting production levels, and Venezuela's taking a more cooperative attitude under the government of President Hugo Chavez.


  That's not to say the OPEC countries are in marvelous shape or that the organization has a rosy future. Decades of trying to micromanage the markets have produced mixed results -- even for OPEC. The Saudis, for instance, find themselves producing only just over 7 million barrels per day -- at least 3 million below their capacity and well below full utilization of their enormous reserves, which account for about 25% of the world total.

By playing the OPEC game, the Saudis have lost potential market share to Russia, a non-OPEC oil producer that pays only lip service to the cartel's production quotas, and to other growing producers such as Angola and Kazakhstan. Indeed, the Saudis and other big Arab exporters have added little to their capacity in the last decade, while their non-OPEC rivals took advantage of high prices to lure tens of billions in investment from international oil companies.

The Saudis and OPEC are muddling through for now, and prices seems headed north again for the foreseeable future. But the cartel's members may yet come to regret the oil policies they have so assiduously pursued.

By Stanley Reed at the OPEC meeting in Vienna

Edited by Douglas Harbrecht

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