OPEC Update: Get Used to Lower Prices

Perhaps the clearest takeaway from the seminar OPEC held in Vienna at the baroque Hofburg palace on Mar. 18 was a message to the oil industry's hardliners that they had better get used to relatively low prices for some time.

That message was clearest from the Saudi Oil Minister Ali al Naimi, who said that the first goal for the cartel, which has seen prices drop by about 70% since their peak, was to "stabilize prices, which I hope OPEC has succeeded in doing." Naimi said he hoped "for a gradual increase in prices," but conceded that this was unlikely to happen until the world economy improves. Prices are now trading in a range of $40 to $50 per barrel, though OPEC officials worry that another spate of bad economic news could renew downward price pressure.

The Saudis Hammer the Hardliners

The Saudis were apparently even tougher on the hardliners in private, particularly Iran and Venezuela. Before OPEC's Mar. 15 production-setting meeting, those countries argued for another cut beyond the 4.2 million barrels per day announced in Algeria in December. But they were told to forget about it because they were contributing only minimal amounts to the present cuts, while the Saudis were shouldering the burden of almost half of the 3.5 million barrels actually taken off the market so far. The Saudis also are wary of actions that might cause further global economic deterioration.

Nevertheless OPEC seminar participants missed few opportunities to bellyache about prices, even though $40-per-barrel oil would have delighted many of them a few years ago. OPEC's Secretary General Abdallah El Badri, a former Libyan oil official, led the chorus of doomsayers: "At a $40 price, OPEC can't invest in any additional capacity. If we don't have reasonable prices, we are going to have shortages."

OPEC argues that a price of $60 to $70 a barrel is necessary to sustain the investment needed to satisfy what it assumes will be high growth in demand over the next decade or two. While robust demand growth may resume, at present the trend is just the opposite, with global consumption down by perhaps as much as 2.5 million barrels a day from its 2007 peak. OPEC cutbacks have automatically boosted spare capacity to over 5 million barrels per day and rising, according to the International Energy Agency, the consumer country watchdog.

Thin spare capacity was a huge bugaboo that contributed to high prices in previous years. Moreover, Chevron (CVX) CEO David O'Reilly poured some cold water on OPEC's moaning that $40 per barrel was insufficient to justify investment by saying current prices were within his company's range.

Production-Sharing Contracts in Iraq?

But perhaps the most bearish news for OPEC—and most comforting to consumers—was a presentation by Iraqi Oil Minister Hossein Shahristani. Outlining two continuing bid rounds for upgrading Iraqi fields at a cost of $35 billion, Shahristani said that his country could boost its production from its now slightly more than 2 million barrels per day to 6 million barrels per day within five to six years. Shahristani also played some sweet music for the international oil companies contemplating going into Iraq when he mentioned that he was considering offering exploration acreage for production-sharing contracts—the Holy Grail of the oil industry.

The current deals on offer in Iraq are rather unappetizing contracts that pay the companies for incremental production boosts of existing fields. While Shahristani's projections are likely to prove optimistic—if not wildly so—OPEC will have yet another problem to deal with if Iraq's oil development program finally does start to gain some traction. Iraq is the only OPEC country exempt from quotas.

Shahristani pointedly said that Iraq sought "a fair market share for crude oil and gas on the world market." Six million barrels per day would make Iraq second only to Saudi Arabia among OPEC producers and might well trigger a major shake-up in the producers' club.

Before it's here, it's on the Bloomberg Terminal.