Is OPEC Readying a New Price Band?

OPEC floated a trial balloon last week about further limiting crude oil production. Just about every oil customer in the world howled.

Reports last week from Jakarta stated that OPEC president Purnomo Yusgiantoro said at a press conference the cartel was studying whether to increase its target price range by 30 percent. OPEC does not set prices directly, but adjusts production quotas so that prices rise or fall within a target range. A 30 percent jump would lift the target range from $22 to $28 a barrel to between $29 and $36. That range would include current prices which are running above $32. It would amount to a de facto price increase.

The consuming public as well as international organizations suffering from high retail gasoline prices in parts of the U.S. did not respond positively. Protests came from California to New York where gasoline was running above $2 a gallon, as well as from the rest of the U.S. where prices were averaging above $1.80.

A week earlier, OPEC denied a Reuters report that it had "quietly introduced a new formula for assessing its reference crude price that takes into account exchange rate moves." The story, attributed to OPEC officials, further stated that "the Secretariat is running a new trial Crude Oil Basket in parallel with the existing one..."

The OPEC Secretariat said, "The OPEC Reference Basket price is still calculated using the same formula, which is based on a simple average of closing quotations of the seven crudes that make up the Basket." The crudes comprise Sahara Blend, Bonny Light, Dubai, Minas, Arab Light, Tia Juana Light, and Isthmus.

Economists and government officials, already fretting about possible damage to the growing world economy, feared the worst. The G7 group of ministers, finishing up a meeting in Washington, said high oil prices are virtually the only threat to the economic recovery worldwide.

"The global economic recovery continue[s] to strengthen and broaden since we met in February. Prospects are favorable, and although risks remain, such as energy prices, overall the balance of risks to the outlook has improved," the ministers said in a final communiqué.

The International Monetary Fund said global growth is on track for a 4.6 percent increase this year. That is the best growth since 2000, but it could be dampened significantly by crude oil price increases.

OPEC: Plentiful Crude Supplies
Even though just about everyone seems convinced that OPEC price decisions are behind high gasoline prices, OPEC itself says it's not. There is no shortage of crude oil in world markets according to OPEC. In fact, its recent April 1 production cut is needed to hold prices in the face of the seasonal drop in demand. On NBC's Meet the Press and later at an energy conference in Washington, Saudi Oil Minister Ali al-Naimi said sharp gasoline price increases are mostly in the U.S. and due to lack of refining capacity and balkanized gasoline markets, decline of the U.S. dollar, and speculation in fuels trading. "There is plenty of crude oil available on world markets," al-Naimi said.

Record oil company profits received attention also. BP's first quarter results, reported April 27, showed record profits from gasoline sales. The Santa Monica-based Foundation for Taxpayer and Consumer Rights (FTCR) said that is consistent with their two-year analysis showing the five major oil companies' profits rose in direct correlation to hikes in the price at the pump. Jamie Court, FTCR's president and author of Corporateering (Tarcher/Putnam) said, "If greater OPEC crude costs were truly driving up the price of gas, rather than price gouging, oil company profits would not be soaring."

No New Major Refineries
Some of OPEC's contentions about factors affecting the U.S. market are borne out by the evidence. The recent decline of the U.S. dollar in relation to the Euro, seen on virtually every financial page, has resulted in much higher percentage increases in gasoline prices in the U.S. than in Europe.

The U.S.'s capacity to produce refined products, including gasoline and fuel oils, has created a definite bottleneck. The Alliance for Energy and Economic Growth reviews this factor in a White Paper on Petroleum Refineries. The paper points out, first, that no major refinery has been built in the U.S. in 25 years. Second, economic growth at an average annual rate of 3.3 percent has led to an increase in demand for refined products of 17 percent. Refinery capacity expanded by only 7 percent in the same period. To help ease the resulting shortfall, refineries have boosted operating rates from 86 percent to 93 percent on average with 95 percent during peak seasonal demand. Even so, The U.S. has had to import increasing amounts of refined products--increasing from 3.5 percent to 9 percent of demand over the past 10 years. The Alliance says those percentages are likely to increase in the years ahead because of the many factors that hold up building new refineries. These include complex permitting procedures, regulatory uncertainty, poor rates of return, outdated depreciation treatment, and the large investment required to comply with environmental regulations.

Third, U.S. refineries must supply 15 different types of gasoline, specialized blends, or "boutique fuels," to meet the various requirements of different regions. This balkanization, as al-Naimi called it, complicates production and limits flexibility in distribution. It increases the potential for supply disruptions and price spikes, while providing foreign suppliers with little incentive to produce fuels solely for the U.S. market.

U.S. representatives acknowledge that these factors could contribute to price increases but still insist that the major factor is high crude oil prices. The U.S. in recent weeks has issued vague calls to "let the market set the prices," which appears to mean OPEC should ease its production limits, if not sell all comers as much as they want.

Clearly the factors driving higher prices are not simple and can't be pinpointed. For now, OPEC appears to not be pinching the taps back quite so far. It did not officially eliminate the April 1 production cut, but it had quit mentioning the 30 percent increase in the price band at press time. But if the U.S. dollar doesn't strengthen or if OPEC doesn't switch to another reference currency, that may not be the last we hear of it.