What's Greasing OPEC's Gears?

The decision to further cut output is sparking heated debate. One thing is for sure: The cartel is playing by different rules now

It was as if OPEC was living on a different planet. On Mar. 31, oil ministers from the cartel's 11 member nations convened in Vienna to decide whether to proceed with planned production cuts. They had plenty of reasons to do the opposite -- and pump more oil, not less.

After all, the price of crude, at around $35 a barrel, has recently been flirting with 13-year highs. Gasoline in the U.S. has never been so expensive -- a potentially risky matter for a White House in reelection mode. While no new national polls are out on whether the public blames Bush for gas prices, aides say the President isn't worried about any political fallout. "The numbers are actually going in our favor right now," says Bush campaign pollster (and chief campaign strategist) Matthew Dowd.

However, the Bush offensive masks a nervousness in GOP-land. While the campaign is confident that it can neutralize voter anger over high gas prices by pointing the finger at tax-hiker Kerry, they worry that costlier fuel could cause a downturn in the economy, particularly in hiring. "If there's a decline in employment growth in July, August, or September, that would be very bad for the President's reelection," says one top adviser.


  And the last thing the nascent global recovery needs are oil prices in the range they're in now. And yet, despite entreaties from the Bush Administration and over the objections of some of OPEC's own members, the global cartel opted to cut production by 4% starting on Apr. 1. The bottom line: Not only is OPEC increasingly willing to risk the displeasure of the U.S. -- a key ally of its most influential member, Saudi Arabia -- it also seems far less concerned that higher oil prices could stifle global growth and ultimately lower demand for oil.

What's going on here? If you believe the rhetoric emanating from Vienna, it's speculators, not OPEC, that are behind much of the recent run-up in oil prices. Saudi Oil Minister Ali Naimi went so far as to say that hedge funds and other investors are responsible for as much as $5 of the current price. The market, said Purnomo Yusgiantoro, Indonesia's Oil Minister and OPEC's president, "is heavily influenced by speculation to the detriment of fundamentals."

OPEC also has fretted publicly about fears that the market could soon be glutted with oil, since demand often falls off when warm weather reduces the need for heating oil.


  Many analysts, however, believe OPEC is being disingenuous. They note that inventories are lower than usual at this time of year, a sign that a glut isn't in the offing. "OPEC does not need to produce the cuts they have promised," says Jan Stuart, vice-president for research at Fimat, oil traders based in New York. The cartel's real aim, say industry observers, is to put a new floor under prices: $28, now the upper end of the range it has been targeting.

Two key reasons exist for the new price target: to keep the petrodollars rolling in at a time when many OPEC states need more than ever to maintain stability at home, and to offset a weak U.S. dollar, the currency in which oil is traded globally. After all, the greenback is worth about 19% less against the euro than it was in 2000 when OPEC set the $22- to $28-a-barrel target.

The production cuts might be disastrous if OPEC adhered to them -- giving non-OPEC nations another shot at grabbing market share -- but most experts expect the cartel to produce well above quota to cash in on the high prices. Experts say it's just one sign that the cartel isn't particularly worried about a glut materializing in a few months. "They'll produce in order to satisfy buyers," says LEO P. Drollas, chief economist of the Center for Global Energy Studies, a London think tank. "And they'll carry on doing so until [prices hit] $28 or $29 a barrel."


  With just about every OPEC country facing the challenge of youthful, fast-growing populations that are vulnerable to the dogma of extremism, it'll take all the money OPEC's oil industries can produce to keep these folks happy and employed. Prices in the low $20s could spell political disaster for the likes of Saudi Arabia or Iran. The Saudis also need money to sustain the high spending of a royal family of thousands of princes and princesses.

OPEC is changing its views of its role in the world economy, too. In the past, the group worried that if oil prices went too high, it would stifle growth and lead ultimately to less demand for oil. In private, the Saudis now say they no longer believe oil prices in the $30s have much of an impact on economic activity. The big consumers such as China and the U.S. are burning up all the oil they can buy. "They think the ability of importing countries to withstand high prices is greater than it has been," sys Edward L. Morse, senior adviser at HETCO, a New York energy-trading firm.

The Saudis also shrug off worries about political fallout in the U.S. An Administration source told BusinessWeek that Secretary of State Colin Powell and President George W. Bush asked Saudi officials to delay a production cut and were told that Washington didn't have to worry -- the situation was under control and a cut wouldn't happen. But it did.

The Saudis may have concluded that their continuing cooperation on the war on terror is more important to the U.S. than keeping oil prices low. As long as the Saudis keep up their anti-al Qaeda cooperation, they figure they can keep charging what the market will bear for their oil.

By Stanley Reed in Vienna, with Stan Crock and Richard S. Dunham in Washington

Edited by Beth Belton

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