OPEC, Mindful of Politics, May Informally Cut in Coming Months

VIENNA, March 4, 2008 (Dow Jones Newswires)

Mindful of the political challenge of slicing oil production at a time of triple-digit crude prices, OPEC may opt to informally trim in the coming months as it seeks to act ahead of an anticipated slowdown in energy demand.

The Organization of Petroleum Exporting Countries holds its second meeting of the year Wednesday as oil prices skirt all-time highs and a surge of investment suggests they could move higher still.

The price surge has come at a time when the oil producing body, which accounts for 40% of the world's crude supply, might otherwise be considering a cut in production, with global oil inventories ample and a slowdown or possible recession looming in the U.S. economy.

Some voices within the group - principally Iran, Algeria and Venezuela - have come out in favor of a production cut now. But the oil price surge - New York crude futures hit an all-time inflation-adjusted high of $103.95 a barrel Monday - has rendered it politically difficult for OPEC to take barrels off the global oil market, a view endorsed by many ministers.

Still, analysts believe that with so many questions hanging over the U.S. economy and oil inventories in the world's largest energy consumer once again on the rise, OPEC will push through a cut in production at some point.

"Once U.S. headwinds feed through with a clearer picture that demand is actually easing, it could send prices lower," said Bill Farren-Price, energy director at Medley Global Advisors. "They've got to cut at some point, whether it's officially or unofficially."

Record Prices A Strong Incentive To Keep Pumping

With oil prices this week surpassing their cash market equivalent record hit in April 1980 in the wake of the Iranian Revolution and start of the Iran-Iraq war, the incentive to keep pumping on all cylinders is strong. Even now, most OPEC members are producing at near full capacity, the main exception being OPEC heavyweight Saudi Arabia.

The kingdom is pumping about 9.2 million barrels a day, above its OPEC quota of 8.9 barrels a day, but some way below its known capacity. If OPEC were to agree on raising production, Saudi Arabia would be most in a position to do so, as the only true custodian of spare capacity in the group. But there's little evidence to suggest the world's largest oil producing nation is inclined to raise output in a market where oil demand is slowing and inventories are rising.

Instead, suggests David Kirsch, head of the markets intelligence group at PFC Energy in Washington, Saudi Arabia over the next several weeks will likely seek to take more heavy oil of the market.

He said Saudi Arabian Oil Co., or Saudi Aramco, will shrink the discounts it applies to its Arab Heavy and Arab Medium grades of crude-oil relative to the price of the benchmark price for high-quality crude, especially to the already well-supplied U.S. market. Saudi Aramco probably will also allow its regular buyers to take smaller volumes, Kirsch said. This could help ease expected second-quarter inventory builds, which could force regional high-sulfur crude grades to catch up in price relative to the benchmark.

Kirsch said the kingdom used this strategy successfully in 2006 to remove 300,000 barrels a day from global markets before OPEC was asked to make similar moves.

"The Saudis certainly have some room to tighten the taps quietly in order to consolidate the gains OPEC has achieved over the past year and a half," he said in a report.

Developing World Demand Is Big Question

A big question in this scenario over the next few months centers on demand in the developing world, particularly India and China. A recession in the U.S. already presents a worrying picture for oil demand from an OPEC perspective, but one made more worrying if it spreads to the locomotives of the developing world.

"Resistant oil demand in Asia and the Middle East is based on a perception of a less degree of linkage between the U.s. economy and Asian economies," said Tor Kartevold, a special adviser on oil trading to Norway's StatoilHydro ASA (STO). "The jury is still out on that."

He said the demand outlook in the U.S. could worsen the longer oil stays around $100 a barrel.

"We won't know this for a few months," he said.

Already, large consuming nations have ratcheted up the pressure on OPEC to bring more oil to the market and alleviate scorching prices.

"I think it's a mistake to have your biggest customer's economy slow down, or your biggest customer's economy slowing down, as a result of high energy prices," said President George W. Bush on Tuesday. "My advice to OPEC is understand the consequences of high energy prices."

VIENNA, March 4, 2008 (Dow Jones Newswires)