In a surprise move, OPEC decided Tuesday to cut its production of crude oil immediately and lower output quotas by another 1 million barrels a day effective April 1. The move comes amid widespread cheating on existing quotas and fears that a coming slowdown in demand brought by warmer weather could send oil prices lower.
The Organization of Petroleum Exporting Countries expects the combined cuts would reduce actual production by about 10 percent, or 2.5 million barrels a day. OPEC pumps about a third of the world’s oil, and its members are currently producing about 1.5 million barrels a day above their output ceiling.
The move to cut output took most OPEC watchers by surprise. At its meetings, the cartel often urges members to stop cheating, but the decision to cut its official target of 24.5 million barrels was unexpected.
Oil prices, which have been trading above $30 a barrel, rose further Tuesday on news of the OPEC quota cuts, which the markets took as a signal that the recent boost in the flow of oil may be drying up.
Oil prices are near the top of a $6-a-barrel winter spike, fuelled by tight supplies combined with cold weather in key heating energy consuming regions.
But the second quarter is typically a slack period for demand – as warmer weather cuts consumption of heating oil and the summer driving season, along with peak demand for gasoline, is still months away.
“As time goes on in the second quarter, we will see a drop in demand that will affect prices. If we don’t do anything, there will be oversupply in the second quarter of about 3 million barrels (a day),” OPEC president Purnomo Yusgiantoro told a news conference at a government-run convention center in Algiers.
Though a recovering U.S. economy and vigorous growth in China have boosted demand more than many had anticipated, many industry analysts agree that a drop in demand is likely during the April-June quarter.
“They clearly have to start cutting production now,” said Yasser Elguindi, an analyst at Medley Global Advisors, a New York consultancy.
If the cartel sticks to its plan, consumers will continue to face high prices for refined products, analysts said. The move comes on top of changes in regulations banning a fuel additive designed to make gasoline burn more cleanly that is required in many parts of the country.
"Because of all the new regulations on gasoline, we're going to be paying a record high price on gasoline,” said Phil Flynn at Alaron Trading. “We're going to have problems this year with gas prices.”
OPEC countries fear that unless the cartel cuts back, it risks forcing prices sharply lower, at a time when OPEC producers have come to rely on high oil prices.
“Last year was a great year for OPEC,” said Daniel Yergin. “They made 25 percent more than they did the year before. They made about $250 billion, and they don't want to see that money go away.”
OPEC is still smarting after its 1997 agreement to boost production just before an Asian financial crisis that sent oil prices plummeting to $10 a barrel. The group has tried recently to take pre-emptive steps to prevent another such price collapse. In September, it defied predictions of an unchanged production target by announcing a 900,000 barrel cut in its output ceiling.
But cutting production also means cutting oil revenues, a move many oil producers can ill afford.
“I think it is going to be almost impossible for them to cut back and not cheat,” said John Kilduff, an oil analyst at Fimat USA. “The Algerian minister said it’s much easier to raise output then cut back. When oil is over $30 a barrel they are like dieters at a dessert table, they can't resist producing more.”
Though OPEC has a long history of pumping oil in excess of its quotas, Kuwait’s oil minister Ahmad Fahad Al-Ahmad Al-Sabah said its members would be much more serious this time.
“All the signals and all the studies show that the second quarter will be a very bad quarter ... Everybody, for his benefit, has to be strict with these resolutions,” the Kuwaiti minister told reporters.
The White House responded to the OPEC news by saying it hoped the cartel did not take actions that hurt the U.S. economy.
“It is our hope that producers do not take actions that undermine the American economy and American workers, and American consumers for that matter,” White House spokesman Trent Duffy said.
(The Associated Press, Reuters and CNBC's Melissa Francis contributed to this report.)