OPEC Cuts Have Buoyed Price, But At A Cost

NEW YORK Aug 31, 2007 (Dow Jones Newswires)

Organization of Petroleum Exporting Countries crude oil output cuts have succeeded in stabilizing prices, but likely haven't cut deeply enough into global stockpiles to sanction a production increase at the group's Sept. 11 meeting.

"As I see it at this time, there's enough crude in the market," OPEC's Secretary General Abdalla El-Badri said Tuesday.

He appeared to hint that OPEC will officially keep output restraints in place when it meets at its Vienna headquarters in less than two weeks and take up the issue again at its scheduled Dec. 5 meeting in the United Arab Emirates.

"We'll review the market and we'll see what we can do in September, but the picture at this time is not clear. It will be clear to me in December what's going to happen in the American economy," he said, referring to unfolding credit crunch that has sparked fears of an economic slowdown.

Traditional price hawks Iran and Venezuela have in recent days called for OPEC to continue output restraints. OPEC's de facto leader, Saudi Arabia, the world's biggest oil exporter, typically has yet to tip its hand ahead of the meeting.

On July 11, Saudi Oil Minister Ali Naimi said prices near $72.50 a barrel weren't justified because "there is a good balance between supply and demand." He said then that the level of inventories - "higher than they have been in the past five years" - were "very, very comfortable."

Indeed, an Energy Matters review of the oil market since Oct. 20, 2006 - when OPEC agreed to its first production cuts in two years - shows the group revived prices, at a hefty cost in revenue and market share, but hasn't significantly dented global inventories.

Data from the International Energy Agency, the energy watchdog of the major industrialized nations, show that inventories held by those nations in October 2006 were sufficient to cover 54 days of demand.

In its latest report, dated Aug. 10, IEA said stocks at the end of June remained at 54 days cover. IEA's next report, measuring end-July stocks, isn't due until Sept. 12, a day after OPEC convenes its ministerial conference.

Pre-Meeting OPEC-IEA Talks

OPEC's El-Badri is set to meet Nobuo Tanana, the incoming IEA executive director, on Sept. 5, sources close to the talks said, but it's unclear what's on the agenda.

IEA has repeatedly pressed OPEC to increase oil output, warning that world oil demand is likely to outpace supply this winter and the gap will widen if OPEC decides not to raise crude production on Sept. 11.

OPEC's caution in the current environment speaks to the hard lessons learned from the ill-timed decision in Jakarta in November 1997. A move to lift output quotas by 10% corresponded with the start of the Asian financial crisis and an unusually warm winter in the Northern Hemisphere. In the following months, prices fell by nearly 50% to below $11 a barrel in December 1998 and didn't recover to pre-Jakarta levels until late summer 1999 after several OPEC output cuts.

Prior to the Jakarta meeting, the IEA had projected that global oil demand would rise by 3.3% on the year in the fourth quarter of 1997. In reality, it grew only 2.4%. In the first quarter of 1998, global demand rose just 0.8% on the year, against the IEA's projection of 3.1% growth.

Last autumn, acting to staunch a downward spiral in prices, OPEC acted to cut output beginning Nov. 1 by 1.2 million barrels a day and lifted the size of the cut to 1.7 million barrels a day from Feb. 1, 2007.

The price of OPEC's reference basket of crudes fell by more than one-third from an early August 2006 high of $72.68 to $54.10 on Oct. 4, spurring the cut agreement. The basket price rebounded to a record $73.67 this July 20.

Energy Matters tracked OPEC's basket price over the 220 days since the Oct. 20, 2006 cut agreement and compared it with the same period prior to the agreement. Remarkably, prices have stabilized to average $61 a barrel since the cut was decided, just 66 cents, or 1%, below the prior 220-day period, dating back to mid-December 2005.

Revenues Down $86 Million A Day

Since the OPEC cut agreement, the average front-month crude oil futures price on the New York Mercantile Exchange is down 5.1%, compared with the prior 220 days.

OPEC's basket tracks a broader variety of crude and is more representative of the market than Nymex prices, which can be subject to wide swings around contract expiration and due to heavy speculative trading.

Output from the 10 OPEC members (excluding Iraq and Angola) in the group's quota system fell by 1.1 million barrels a day, or 4%, from levels in the 220 days prior to the cut agreement. Output restraints and lower prices cut the value of OPEC-10 production by 5%, or $86 million barrels a day, to $1.62 billion a day.

Based on IEA data, global oil demand averaged 1.2%, or 1 million barrels a day higher since the output agreement, than in the 220 days before the deal. Despite the rising demand, the cuts meant OPEC's share of the global market slid to 31.2% from near 33% before the deal.

The value OPEC's oil revenues were further hit by a 6.6% decline in the value of the dollar (the currency in which oil is priced globally) against the euro. On average, the dollar was equal to 80.5 euro cents prior to the cut and just 75.2 euro cents since the cut.

OPEC may chalk up the costs to the price of doing business and find them cheap, compared with the impact of a post-Jakarta-size price collapse.

All these factors combine to make a powerful argument for OPEC to hold the line on production - officially - while some countries may ease more barrels into the market ahead of a likely December policy review.

Antoine Halff, energy analyst at Fimat USA in New York, said OPEC's apparent success in stabilizing prices isn't shared equally.

"I guess one could argue it's been a success for the (OPEC) countries that have been struggling to keep production going even at reduced rates," he said. "Having Saudis and ... others with spare capacity agree to cut their own output has stemmed the bleeding for the likes of Iran, Nigeria and Venezuela."

Copyright (c) 2007 Dow Jones & Company, Inc.

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