Opec's choice

QUERETARO, Mexico, Nov. 1 (UPI) -- The price of oil has dropped well below the Organization of Petroleum Exporting Countries' target range of $22 to $28 per barrel. OPEC's basket of crude is now trading for less than $20. When OPEC meets in Vienna Nov. 14 it has to do something to push prices up or drop its price range. The outcome of the minister's meeting will have an impact on the global economy.

In recent weeks OPEC President Hugo Chávez of Venezuela has been pushing hard for the organization to cut supply to bolster the price of oil. But there is a trade off to be considered. If OPEC cuts supply and thereby sustains the oil price, non-OPEC producers tend to gain market share. OPEC therefore has a choice to make.

This challenge follows a period in which the organization has reasserted itself. In 1998-2000 OPEC showed unexpected discipline on quota compliance and drove prices up. This economist, for one, was taken by surprise. So was The Economist magazine, which, shortly before the surge in the oil price, published an article, which argued that the price of oil might slump to just $5 per barrel.

This year, however, OPEC's discipline has weakened. OPEC countries have been cheating on quotas and producing too much oil. In a meeting in July, OPEC countries agreed to cut production in September. But in September they were still producing over quota. As U.S. and world economic growth slows, and, with it, global oil demand, oil prices have fallen significantly, by about a third for most crudes in the past twelve months. But, in October, there are signs that OPEC is showing fresh resolve.

James L. Williams, an oil industry consultant of WTRG Energy Economics reported Tuesday that OPEC output appears to have dropped by 450,000 barrels per day in October by comparison with September, to 24.05 million barrels per day, a drop of 1.8 percent.

Will this cut support prices, or even drive them up? The calculation is not so easy to make. With oil, Williams points out, you are always forecasting the historical numbers: it is six months before the levels of production and demand become clear.

Paul Horsnell, oil analyst at J P Morgan Chase, an investment bank, would no doubt agree with Williams' assessment of the difficulties of measuring this market. In research published a week ago, Horsnell argued that consensus has grown within OPEC on the need for a production quota cut of 1 million barrels per day at the November 14 meeting. But, in Horsnell's estimation, the cut is necessary not because the market is over-supplied but simply because the market perceives it to be over-supplied.

Horsnell argues that in order to achieve the same balance between demand and supply as in the fourth quarter of 2000, when oil prices were over $30 per barrel, OPEC needs to reduce production to 27.22 million barrels per day. Horsnell points out that according to one set of figures, those from the International Energy Agency in Paris, OPEC was producing almost exactly this amount in September.

Thus Horsnell writes that if OPEC agrees to a substantial production cut in its November meeting, it will be "taking real barrels of supply to counter what are at the moment just psychological barrels of lost demand." Horsnell therefore concludes that price risk "would appear to be balanced to the upside." That would be bad news for the world economy in general, but good news for oil exporters and for oil companies, which are always more profitable when the commodity they extract and trade is high in value.

Williams, meanwhile, estimates that a 1 million barrels per day supply cut could push up world oil prices by between $3 and $5 per barrel: a substantial increase that would just about be enough to take OPEC's crude back into OPEC's target range. But Williams points to some of the difficulties OPEC faces if it seeks now to manipulate prices. If all sources of petroleum (crude, lease condensate, gas liquids and refinery gain) are included, OPEC's output represented 39 percent of world petroleum output for the first 7 months of the year, but only 32 percent of total world petroleum in the form of crude oil, which is subject to OPEC's quota system. According to Williams, "this means that OPEC is producing almost 40 percent of the world's petroleum but attempting to control prices with a little better than 30 percent."

OPEC has not helped itself by increasing its production of natural gas liquids, which Williams describes as essentially a fine crude that, for historical reasons, is not subject to quota. OPEC's drilling of natural gas liquids was up by 77 percent in the first seven months of this year compared with a year earlier, and is running at 1.7 million barrels per day.

Another problem is that non-OPEC producers have increased their production significantly in the past few years, in response to higher prices. Williams estimates, for example, that Russian production of crude has climbed by about half a million barrels per day since 1998.

Against all this must be set the demand side. The U.S. economy contracted in the third quarter, Japan is in recession, and Germany's growth will be less than 1 percent this year. And after the Sept. 11 terrorist attacks, people are proving less willing to fly and demand for jet fuel has slumped. Unless the U.S. economy rallies strongly, demand for oil is going to weaken further, especially once the northern hemisphere winter is over.

Williams therefore judges that there is a real risk of a collapse in oil prices, especially in the northern hemisphere spring, and it is this risk that OPEC must try, for its own sake, to avert.

Williams sees as being important the announcement today by OPEC President Chakib Khelil of Algeria that OPEC output reductions agreed to at the November 14 meeting will not be implemented until Jan. 1. In Williams' view, this is a signal that OPEC "may have abandoned the price range in favor of market share."

If OPEC wanted to seize its opportunity to push prices up, it would cut production in December and thereby begin to squeeze supply in the northern winter. But that, Williams feels, would be a tactical error by OPEC, which would invite a collapse in prices in the spring. By allowing prices to remain relatively low now, OPEC has an opportunity, Williams believes, to deter some rival non-OPEC production and to retain or even gain market share at the lower price.

Who are the key decision-makers? Saudi Arabia, United Arab Emirates and Kuwait will meet November 5-7 in Riyadh. Between them, they control three-quarters of OPEC's capacity to produce in excess of quota. Saudi Arabia, more than any other country, will guide the decision. It is the world's biggest and lowest cost producer of oil and it is no longer willing, Williams feels, to curb its production so as to benefit other producers. Saudi Arabia may want to opt for market share over price. Venezuela's Chávez will be disappointed. Tacitly rather than explicitly, OPEC may abandon its price target.

The picture is by no means clear. The conflict in Central Asia may yet play a role. Curbing of Iraqi output by the United Nations could push prices much higher. Winter could come to the oil producers' aid. But in the spring of next year weak global demand for oil and the rise in oil supply in recent years seem to be pointing in one direction. For the global economy, if not for the oil exporters, that would be good news.

(Comments to icampbell@upi.com)