Oil Market Turns to OPEC Advantage, But Pitfalls Abound

LONDON (Dow Jones Newswires), May 22, 2009

Global oil markets have turned in OPEC's favor after months of drilling a hole in the cartel's coffers, but internal wrangling in the producer group could still cap recent oil-price gains.

The Organization of Petroleum Exporting Countries' deep production cuts over the past five months are beginning to whittle down a mountain of excess supply. World crude demand appears to be stabilizing and will get a top-up with the start of the summer driving season in the U.S. and Europe after plunging for much of the past year.

Economic recession has slashed drilling investment in non-OPEC nations like Canada, fanning a "fear-of-the-future" mentality among many traders that crude supply will once again tighten as the economy recovers. Fewer non-OPEC barrels down the road will bump up the world's reliance on OPEC crude, which currently supplies about four in 10 barrels consumed daily worldwide.

All those factors give OPEC ministers something to crow about when they meet Thursday in Vienna: Although still relatively weak, oil prices are up about 35% since their last meeting two months ago. With such price increases a threat to the fragile global economy, OPEC seems set to keep its oil spigots steady at its meeting, OPEC delegates and officials said.

Crude traded Friday in New York around $61 a barrel, near a recent six-month high, although prices remain well below a record high of $147 a barrel hit last July. Beyond the fillip from OPEC output cuts, oil prices have also gained support from speculative froth, refining glitches and new Nigerian militant attacks on energy infrastructure.

"Prices are higher than OPEC could have hoped for and expected. Had OPEC not cut the way it did, prices would have fallen to $20 (a barrel) or less," said Leo Drollas, deputy executive director and chief economist at the Centre for Global Energy Studies in London.

Saudi Arabia, the cartel's largest producer and the only OPEC nation in the G20, has added incentive to keep production steady because it doesn't want to be seen spoiling the G20's big stimulus plan for the ailing world economy, announced in April, by backing measures that could sock consumers with higher oil prices.

Millions of consumers globally are still struggling with sharp reductions in personal wealth, large debts and rising job losses that have yet to bottom out in many nations.

"With the current and more optimistic economic indicators, and prevailing oil prices, I think OPEC will preach compliance" with the group's past output reductions, said one senior Gulf OPEC delegate.

That sentiment is echoed by other OPEC officials for additional reasons. Irritation has grown among Gulf OPEC producers that less disciplined members -- namely Iran and Venezuela -- still aren't pulling their weight with OPEC cuts totaling 4.2 million barrels a day announced in late 2008.

Adherence to those reductions, divvied up in output quotas for each member, had been at just over 80% in past months -- good by historical comparison -- but it's now slipping.

OPEC said earlier this month that the group's 11 quota-bound members had raised production in April by around 200,000 barrels a day, the first rise in nine months. Most of that increase was driven by Angola, Iran and Venezuela, according to OPEC data.

Although wanting to see oil prices north of $70 a barrel, OPEC states have been hit hard by weak crude prices and financial pressures from the downturn. To ease the pain, some members are trying to capitalize on the recent price upside by leaking more barrels into the market.

The lack of compliance angers members like Saudi Arabia, which has cut its output by slightly more than its OPEC quota requires. The added production from the likes of Iran hampers OPEC efforts to mop up excess supply in the global system -- and could keep a lid on prices or even push them lower.

Recent OPEC laxity is just part of the reason some analysts say the group isn't out of the woods yet and why continued price increases are far from a given.

"OPEC has cut a lot of production, but the near-term fundamentals are not good and we still haven't a clue how and when demand recovers," said Antoine Halff, deputy head of research at Newedge USA in New York.

Bloated oil inventory in the U.S., the world's biggest oil consumer, has started to ease from a two-decade high level, but will take many more months to drain off to more normal levels.

While some broad data points from the U.S. and China -- the world's second biggest oil consumer -- suggest economic activity isn't as bad as it's been, many energy analysts still expect global oil demand this year to contract by at least 2%, one of the steepest drops in 30 years, and to grow at a snail's pace next year.

There are other reasons there won't be much backslapping Thursday. OPEC's effective spare production capacity, a critical backup supply cushion for global consumers, is expected to rise by about 1 million barrels a day to roughly 6.5 million barrels a day by the end of 2009. That's at least three times higher than OPEC's preferred level.

The added pumping capacity, most of it held by Saudi Arabia, is a function of OPEC producing fewer barrels and new oil projects entering service. The kingdom is scheduled next month to start up its giant $10 billion Khurais project, which will eventually pump 1.2 million barrels a day of high-quality crude.

So far, many traders have looked beyond the thicker supply cushion -- the biggest in seven years -- and focused on how expected growth in emerging market demand will be fully slaked down the road.  

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