How Real Is OPEC's Production Cut?

OPEC says it will take 520,000 barrels off the market, but details are unclear. The move hasn't impacted oil's recent price slide

OPEC's production-cut announcement in the wee hours of Sept. 10 took nearly all the weary reporters and analysts assembled in OPEC's packed Vienna headquarters by surprise. Saudi Arabian officials, who usually call the shots at OPEC, were telling their contacts before the meeting that they were happy with the current state of the market and not terribly worried by the 30% fall in prices since mid-July. In fact, Ali Naimi, Saudi Arabia's dapper oil minister, said more than once with satisfaction that the desert kingdom had worked very hard to bring prices back down to earth from near-$150-per-barrel levels.

So why a cut? The answer is that in the strange world of OPEC, where words have special meaning, this cut may not be a cut at all. For the sake of unity in the organization, the Saudis appear to have yielded to pressure from hard-liners such as Algeria, Iran, Libya, and Venezuela to put what at least seemed like a cut into OPEC's post-meeting communiqué.

Saudi Arabia: Acting On Its Own?

But no specific numbers were spelled out. Instead, a complex formula was devised that isn't easy to interpret. OPEC members will now comply with September 2007 production quotas adjusted to include new members Angola and Ecuador and excluding Indonesia and Iraq. Chekib Khelil, OPEC's hard-line president and the energy minister of Algeria, told the post-meeting press conference that the new regime would mean taking 520,000 barrels of oil per day off the market, but just where these barrels would come from was far from clear. While prices rose after the meeting, they have been weakening since, contributing to the perception "that this cut will have no material effect," writes Edward Morse, energy economist at Lehman Brothers (LEH).

The hard-liners would like the Saudis to trim back the 500,000 barrels or so per day they have added unilaterally in recent months. But after the meeting the Saudis continued to repeat their mantra that they would supply all the oil their customers asked for. The bottom line appears to be that the Saudis will let their own production rise and fall with the demands of the market rather than fall in line with OPEC hard-liners, who want to put a floor of around $100 per barrel under prices. If demand falls later this year and in 2009, as is quite probable, so be it.

At a briefing in London on Sept. 11, Christophe de Margerie, the CEO of the French oil giant Total (TOTF.PA), chastised reporters for not taking earlier Saudi efforts to cool down prices seriously. Alarmed by surging prices, the Saudis called an emergency summit in their second city of Jeddah in June and promised to produce whatever oil the market needed. De Margerie stressed that this was Saudi Arabia acting without OPEC. Indeed, Khelil, the OPEC president, called a press conference in his hotel room at the conference and expressed his strong disagreement with the Saudi output increase. There's always some doubt about OPEC, de Margerie said. "Are they going to deliver? But this was not OPEC, it was Saudi Arabia." He pointed out that no less a personage than Saudi Arabia's King Abdullah had lent his weight to the message by presiding over the conference. This "was a coup de knife in the system of OPEC," de Margerie said. Since the Saudi conference in June, the 500,000 barrels per day in additional Saudi supplies, a strengthening dollar, and weakening demand all had a negative impact on prices.

Bearish Forecasts

Now comes the ambiguous outcome of the latest OPEC meeting. Closely analyzed, the OPEC communiqué was quite bearish for prices. It talked about "a weakening world economy" and "concomitant lower oil demand growth." The Saudis already may be trimming back production in line with reduced customer requests. The International Energy Agency, the Paris-based watchdog, reported Saudi production at 9.46 million barrels per day for August compared with the longtime high of 9.7 million or so that the Saudis say they produced in July.

There seems to be a good chance that prices will continue to fall. On Sept. 10, analysts at Barclays Capital (BARC.L), longtime bulls on oil prices, slashed their forecast for the average price for the 2008 fourth quarter, from $123.90 per barrel to $97.50. Barclays pronounced "just as in late 2006 and early 2007, the stabilization and recovery of prices will be a long process."