OPEC Draws Fine Line Between Oil Balance, Chaos
Members of the Organization of Petroleum Exporting Countries will hold their first meeting of the year next week and, following steep declines in oil prices and ahead of European Union sanctions on Iran, they should have plenty to talk about.
"A month ago, it seemed like the quota meeting would be pretty boring, but maybe not now," said Michael Lynch, president of Strategic Energy & Economic Research and a scheduled speaker at the coming OPEC conference.
"The recent drop in prices is causing some pain in countries like Venezuela and Iran, and they will push for an earlier reduction in production quotas than the Saudis are likely to agree to," he said.
OPEC members are gathering in Vienna for their official meeting this coming Thursday. The election of a new secretary-general to succeed Abdalla El-Badri of Libya, which could provide a road map to OPEC's next steps, will be closely watched. But more immediate concerns may get the most play.
"The main topic for discussion is no doubt the 15% decline in Brent crude prices in May that brought the benchmark below $100 for the first time in 240 days," said Kirk McDonald, senior research analyst at St. Louis-based Argent Capital Management.
Brent crude on ICE Futures in London closed below $100 a barrel June 1 for the first time since early October. It finished at $99.93 on Thursday. OPEC's basket price, a weighted average of oil prices from various oil-producing nations, was at $96.19 on Tuesday.
Futures prices for West Texas Intermediate crude trading on the New York Mercantile Exchange also have fallen 14% since the start of the year. They've lost 18% quarter-to-date to $84.82 a barrel through Thursday.
When members of OPEC met Dec. 14, the oil market appeared to have found a sense of balance, with Brent crude trading relatively stable above the $100-a-barrel level during the second half of 2011, despite OPEC's failure to come to a production agreement at the meeting in June of that year.
In December, members decided to "maintain" OPEC's total production level of 30 million barrels a day, though it wasn't clear whether the group was actually maintaining output or legitimizing overproduction.
OPEC output has been outpacing the target ceiling, partly because producers are anticipating a sizable decline in Iran oil exports once EU sanctions officially take hold July 1.
A Platts survey of OPEC and oil industry officials and analysts showed that OPEC members' output in April was 31.7 million barrels a day, up 320,000 barrels from a month earlier, with Saudi Arabia's up 50,000 barrels from March to nearly 10 million barrels a day.
The Saudis increased output during the first half of 2012 in part to help replenish global inventories in advance of the pending EU embargo of Iranian crude, said Eric Gordon, equity research analyst at investment management firm Brown Advisory in Baltimore.
While the consortium is currently producing nearly 2 million barrels a day above the collective 30 million barrel-a-day target agreed to in December, "seasonal summer demand strength combined with uncertainty regarding Iranian crude exports in the very near future makes it difficult to predict a reduction in output among remaining OPEC producers," he said.
Iran Clouds View
Indeed, with so much uncertainty surrounding Iran, OPEC will have a cloudier picture of oil supply and demand and may decide to do nothing at all with its output level.
"With the EU sanctions against Iran due to come into effect in less than a month and a new round of nuclear talks set for Moscow on June 18 between Iran and world powers, we may see a return to the bullish geopolitical element that pushed [Brent] oil prices up to their highest level since 2008 earlier in the year," said Dubai-based Kate Dourian, editor in chief, Middle East, at Platts.
Overall, "the potential disappearance of even more Iranian crude from markets will make it hard to assess what supply fundamentals will look like in the second half of the year since no one knows how much oil Iran will be able to sell beyond July 1," she said.
So if OPEC members choose to take any sort of action at the meeting, all they can do is "repeat the action they took in December, when they effectively formalized overproduction and set a ceiling of 30 million barrels per day for all 12 members ... without establishing formal quotas," she said.
A new round of U.S. financial sanctions on Iran will also come into effect June 28.
Previous sanctions on Iran have made it difficult to do business with the country, according to the U.S. Energy Information Administration.
As a result, Iranian crude production will likely fall by about 500,000 barrels a day by the end of 2012 from the country's output level of 3.55 million barrels a day at the end of 2011, reflecting "a lack of investment," the EIA said in a recent monthly report.
If the investment issues worsen, "other OPEC members would simply dip into their spare oil capacity," said Andrew Schrage, editor and founder of Money Crashers, a personal finance blog.
So "even with tumbling [oil] prices, few OPEC members have backed off production," he said. "They actually improved production to offset concerns about Iran's supply levels."
Those concerns over Iran helped build what the oil market referred to as a "war premium," as Iran ratcheted up threats to disrupt oil shipments through the Strait of Hormuz in the wake of the EU embargo, U.S. financial sanctions and the ongoing dispute over Tehran's nuclear program.
"While the market risk premium associated with Persian friction has arguably abated in recent weeks, the underlying supply risk remains," said Michael Peterson, managing director of energy research at MLV & Co.
At the same time, "June marks the beginning of the summer driving season in the Northern Hemisphere as well as the start of peak demand for global oil," he said. So "enacting supply constraints at this point along the seasonal demand curve could unintentionally drive prices well above OPEC's comfort level."
On the Agenda
The global economy, an election and discussions over how to keep prices consistent will also be on OPEC's meeting agenda.
OPEC ministers will discuss the global economic slowdown and its impact on crude demand, as well as vote for the organization's new secretary-general, Argent Capital's Mr. McDonald said. "Currently, there is serious disagreement in OPEC about what constitutes a 'balanced' oil market and the secretary-general is the person who needs to get all of the members in line."
Mr. Badri currently holds the position, but his term expires at the end of this year.
Iraq, Iran and Saudi Arabia, among others, have nominated candidates, according to news reports.
"Given the strained relations between Saudi Arabia and Iran, it is unlikely the Iranian candidate will win," said James Williams, an energy economist at WTRG Economics.
And "the Saudis might object to the Iraqi candidate, Thamir Ghadhban. Ghadhban is a technocrat and would probably do well, but some could see him as a proxy for Iran because of Iran's strong influence on the current [Iraqi] prime minister," he said. "Ecuador's oil minister, Wilson Pastor, could face the least opposition because he has no part in the ongoing Shiite-Sunni and Arab-Persian rivalries."
Whoever wins the election may offer a hint on OPEC's next move.
"The election of the secretary-general might provide insight [into] which viewpoint will dominate future meetings," said Derek Gates, founder of index provider Sustainable Wealth Management in Calgary, Alberta.
"If the new secretary-general comes from Iran, then Iran would be able to set the agenda for the next OPEC meeting in December 2012," he said. "Iran has indicated that they want to keep the production quota as is [in the hope of keeping prices high]. This would support other struggling OPEC nations such as Venezuela."
OPEC members, meanwhile, will also strive for consistency in oil prices at the conference next week.
"OPEC wants to see oil at $100 per barrel, which is a good number for all of them," said Will McAndrew, chief executive of Xtreme Oil & Gas Inc. "If that doesn't happen, things can get pretty contentious."
Iran's cost of production is "extremely high" at a little under $85 a barrel, he said, and while the global price of oil has been above this level, Iran is "dangerously close to the brink."
"If Saudi Arabia keeps increasing production and lowering the price of oil, Iran will boil and burn," Mr. McAndrew said. Under that scenario, "you would see the Strait of Hormuz closed down and the price of oil jump up about $20 immediately, which would coincidentally bring the number to over $100."
Copyright (c) 2012 Dow Jones & Company, Inc.
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