Kemp: Doha Meeting Might Not Matter Much for Oil Prices

Reuters

(John Kemp is a Reuters market analyst. The views expressed are his own.)

LONDON, April 15 (Reuters) - Given the hype which has accompanied the run-up to an oil ministers' meeting in Doha on Sunday, there is a risk prices will fall afterwards it fails to reach an agreement or produces only a weak one.

But expectations for the meeting are already pretty low.

"We cannot know the outcome but if there is to be a production freeze, rather than a cut, the impact on physical oil supplies will be limited," according to the International Energy Agency ("Oil Market Report", IEA, Apr 14).

Given that almost no one expects ministers to agree on a cut, and a freeze would not remove any actual barrels from the market, the scope for disappointment is perhaps limited.

Some analysts argue prices could fall sharply if the meeting fails to produce a significant agreement because it will puncture the sentiment-driven positive momentum that has been driving prices higher.

In this view, ministers must deliver something significant or risk an abrupt deterioration in market sentiment and prices.

But it is also arguable that what has been driving prices higher over the last two months is not just sentiment or expectations about Doha but the prospect of real price-driven rebalancing in the oil market.

The IEA and Goldman Sachs have published commentaries this week entitled respectively "market balance draws near" and "rebalancing gathers pace."

If hedge funds and other market participants are focused on the price-driven reduction in supply and increase in demand, the lack of a substantial outcome from Doha might produce only a short-lived decline in prices.

At this point, no one really knows how the market will react to a weak deal.

The Problem Of Oil

"The problem of oil is that there is always too much or too little", Myron Watkins, professor of economics at New York University, wrote almost 80 years ago ("Oil: Stabilization or Conservation?" Watkins, 1939).

Extreme volatility is the defining characteristic of all commodity markets but none are more spectacular or have as much impact on the fate of economies and nations as swings in the price of oil.

"The basic feature of the petroleum industry ... is that it is not self-adjusting," according to economist Paul Frankel ("Essentials of Petroleum", Frankel, 1946).

The risk associated with finding oil underground; the high cost of exploration and drilling coupled with the low cost of production; high fixed costs in refining, transport and marketing; and a lack of responsiveness in both supply and demand to small changes in price in the short term combine to produce continuous crises, according to Frankel.

Not much has changed in the intervening decades. Watkins and Frankel would recognise the recent panic about peak oil, shale revolution and the subsequent slump in oil prices as another of the extreme cycles that have plagued the modern oil industry since its beginning in 1859.

Production Planning

Frankel argued the recurrent crises made some sort of "planning" by major oil companies, governments, or both, necessary and inevitable.

The only way to tame violent price swings was to employ "eveners" or "adjusters", what would now be called "swing producers", willing and able to balance supply and demand by altering their own production.

"As there is always either too much or too little oil, the industry, not being self-adjusting, has an inherent tendency to extreme crises; this fact has called forth the ingenuity of planners within the trade. As no individual unit can evolve a rational production policy on its own, some sort of communal organization is almost inevitable," Frankel concluded.

The history of the oil industry is largely a history of attempts to stabilise production and prices each of which has ended in failure sooner or later.

Efforts have ranged from the Oil Creek Association founded in 1861, the Petroleum Producers Association of Pennsylvania (1869), Standard Oil (1870s-1910s), and the U.S. oil conservation movement (1910s-1930s), to the Achnacarry Agreement (1928), the Texas Railroad Commission (late 1940s-early 1970s) and OPEC (since 1982).

There is no reason to believe an agreement between OPEC and non-OPEC producers in Doha would have any more enduring success.


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