Remember July 2008, when crude oil reached an all-time high of $147.27 a barrel, lending credence to the principle of “peak oil”, the decade-old doctrine that holds that global crude production will crest sooner than expected and then begin a precipitous decline. Analysts predicted that prices will top $200 before the end of 2009. However, that was not to be. The worst global financial recession since World War II pushed the oil price down to $32.40 in December 2008 and now back near $70. The panic of July 2008 looks another era.
The global financial crisis and the resultant price decline have taken the edge out of the Organization of the Petroleum Exporting Countries (Opec) meetings to review its oil supply policy. One such meeting is scheduled for September 9 in Vienna. Yet, what will the Opec decide at the meeting is crucial to the world’s economic recovery. Most observers believe that the likely decision would be to keep the cartel’s output targets unchanged. Opec officials themselves have expressed surprise over the strengthening of oil prices to more than double of last December’s low even in the face of a sharp decline in demand. Oil at $70 is what many member-countries, notably Saudi Arabia, believe is fair for consumers and producers. The cartel has not altered output targets since it agreed in December 2008 to reduce total production for its 11 members with quotas, excluding Iraq, by 4.2 million barrels a day to arrest the sharpest fall in demand since 1981 as the world fell into recession.
However, it is likely that the status quo decision could cause intra-Opec wrangling. It is well known that the oil cartel is a divided house when it comes to pricing. Venezuela and Iran lead the hawks that want a cut in production to jack up prices.
However, as always, Saudi Arabia, the biggest producer and the only country in the cartel with an excess production capacity at any given time, is the swing state. While Saudi Arabia is said to be in a mood to accept prices as low as $50 a barrel, Iran and Venezuela are among those who need much higher prices to balance their ever-increasing populist budgets at home.
With prices where they are currently and looking up, there is little reason to change supply levels. Oil market fundamentals are also weak, effectively ruling out an output rise, at least until Opec ministers meet again in their next scheduled meeting in December. More so because the cartel’s output discipline has also plummeted to 71%.
It will be interesting to watch how the cartel will force countries which produce above their quotas-such as Iran, Angola, Ecuador and Venezuela-to comply with their agreed output limits.
Oil price volatility will remain a reality as long as there is flat output and rising demand. Secondary sources are coming online, but political strife and underinvestment hinders global exploration. Even the most optimistic oil authorities cannot see production keeping up with demand without a big boost from unconventional sources such as Canada’s vast oil sands. Increased drilling is no cure-all, either; as new projects take about a decade to come online.
The challenge before Opec, with its strong pricing power, is to decide how much volatility is acceptable to both consumers and producers. Record-high fuel costs hit consumers and business like a huge tax increase. Low costs, on the other hand, carry the risk of political destablisation for many producer nations as all of Opec countries depend heavily on oil revenues.
If Opec keeps output quotas unchanged on September 9, it would be making the right call that a bullish market would potentially dampen the world economy?s nascent recovery. By doing so, the Opec will be doing itself a favour–the International Energy Agency has said that oil prices could surge rapidly once demand recovers.