With a global economic slump slowing the demand for oil, the Organization of Petroleum Exporting Countries is moving again to cut production and support prices, as it decided Wednesday to cut crude production by about 4 percent. While over the past few years the cartel apparently has hit on a successful strategy for maintaining prices in a narrow band, its record in controlling oil prices over the past three decades has been mixed at best.
Once the world economy picks up speed again, and its members approach the limits of their production capacity, some analysts think OPEC may run out of room to maneuver.
Since it grabbed the world oil market’s attention with the price shocks of the 1970s, OPEC’s grip on the price of crude has been slippery. Some analysts even wrote off the cartel’s impact during the global economic slowdown of 1998, when internal bickering over production quotas flooded the world with oil, sending prices crashing to $10 a barrel.
And its latest success in sending prices soaring above $34 a barrel is getting part of the blame for the global economic slowdown that is once again squelching demand. So with prices falling, the cartel wants to avoid a repeat of the 1998 price crash that cut off its cash spigot.
“Having suffered at the hands of the Asian economic crisis 30 months go, when prices fell to $10, OPEC is in no mood to take chances with its economic lifeblood,” said Gary Ross of PIRA Energy in New York. “OPEC means business, and we will see growing evidence of tighter markets in the weeks to come.”
OPEC’s efforts to control prices by forecasting supply and demand have been hit-or-miss. That’s because the cartel has traditionally wrestled with the same problem faced by oil producers, consumers and traders: On any given day, no one really knows just how much oil is out there. The most reliable data covers only U.S. inventories, but even those numbers are at best a rough estimate.
That’s why the group earlier this year switched tactics, ignoring forecasts and setting production based solely on price — targeting a basket of crude oil blends at between $22 and $28 a barrel. (That target basket is roughly $3 a barrel cheaper than the U.S. West Texas intermediate benchmark that is often quoted.)
Judging from a price chart over the past few years, the plan seems to be working. After tripling between 1998 lows and 2000 highs, crude oil prices have moved into the narrower band OPEC has said it is targeting.
The latest cuts, to take effect Sept. 1, will pull about 1 million barrels a day off the world oil market, which is currently estimated at about 24 million barrels per day. The latest limits come on top of cuts of 2.5 million barrels a day earlier this year — bringing the total cuts for the year to about 13 percent of OPEC’s production.
Prices have been falling because inventories began building as demand for oil softened. U.S. crude oil stocks of 316 million barrels are some 24 million higher than at this time a year ago. U.S. gasoline, heating oil and diesel stocks of 337 million barrels show a combined 21 million barrel surplus. European and Asian inventories also are back in surplus.
Meanwhile, global consumption is expected to hit 76 million barrels per day this year — a gain of just 460,000 barrels over last year and about half the gain forecast earlier this year by the International Energy Agency. The agency, which represents oil-consuming nations, also cut its demand forecast for next year to a gain of just 780,000 barrels per day.
OPEC’s move to cut production and support prices is still something of a crapshoot. Some analysts believe the recent run-up in U.S. oil inventories is only a temporary phenomenon brought about by the one-time shot in the arm from the U.S. Strategic Petroleum Reserve earlier this year. High gasoline and heating-oil prices have also attracted a flood of imports, swelling U.S. stocks of those fuels.
“There is the potential for a phenomenal distortion in U.S. inventories — which is what we’re pricing oil off of now,” said Marshall Adkins, head of energy research at Raymond James & Associates.
Fudging the numbers
On top of the bulge in inventories, OPEC is also coping with the routine quota cheating that has dogged the group since it first began limiting production. Oil industry analysts estimate current levels of “leakage” at about 800,000 barrels over the official quotas. Iraq, which is supposed to be restricted by United Nations sanctions, is widely believed to be evading those curbs with sales to neighboring states.
But since the 1998 oil-price crash, cheating hasn’t loosened OPEC’s grip on prices. Its new policy of setting production based on price — instead of arbitrary quotas subject to heavy haggling — has also helped to head off the political infighting that has split the cartel in the past.
OPEC’s success in maintaining crude oil prices in a narrow range has a lot of benefits — for all players in the oil markets. Oil producers — including U.S. oil companies — can make safer bets on new production without the fear of oil prices crashing again. Oil consumers can avoid the economic pain of big price spikes. And keeping a reliable floor on prices helps non-OPEC producers, too.
“Oil prices at $10, $12, $13 a barrel are too low — they’re bad for the overall geopolitical situation,” said Bill O’Neill, director of commodity research at Merrill Lynch. “It hurts Russia very badly, for example. Any hope of economic recovery there has to be tied in” with stable oil prices.
But over the longer term, some analysts think OPEC will find it increasingly difficult to maintain its price targets. It’s easy enough to move prices higher by cutting demand. But the latest economic boom pushed most OPEC countries close to their production limits. Once they reach that limit, only a slowdown in demand — or increased production from other sources — will ease prices.
“In three to five years, I would say that OPEC is meaningless because everyone will be running at capacity,” said Adkins.
OPEC shrinking excess capacity has also placed the cartel further in the shadow of Saudi Arabia, which is expected to have significant excess capacity long after other OPEC countries have reached their limits. Once taken for granted, U.S.-Saudi relations have been strained in recent years, as power has shifted from Saudi King Fahd to his half-brother, Crown Prince Abdullah, who now effectively rules the country.
Recent signs of widening cracks in the relationship include the Saudi refusal to extradite 11 suspects indicted by the U.S. in the bombing of a military complex there that killed 19 U.S. troops. The crown prince has also reportedly declined an invitation to visit the White House. The situation became so tense that former President Bush recently called King Fahd to calm the waters, according to published reports.
Analysts say they doubt the strain in relations threatens U.S. oil supplies just yet. For one thing, any interruption in shipments would deprive the Saudis of much-needed income. But the political climate in the region has clearly shifted, and the Saudi government will find it increasingly difficult to maintain a public friendship with the United States, according to Jim Placke, a Middle East analyst at Cambridge Energy Research Associates.
“The information revolution has come to the Arab world as it has everywhere,” he said. “And government no longer controls the flow of information anything like they used to.”
Though it still controls a majority of the world’s oil reserves, OPEC’s impact may also be tempered in the future by increased production by non-OPEC countries. Major U.S. oil companies, for example, sharply curtailed spending on developing new production after prices crashed in 1998. Much of the industry’s overall profit growth since then has been through consolidation — capped by the mergers of Exxon and Mobil and the pending merger of Chevron and Texaco. By squeezing more efficiency out of their operations, these companies were able to grow profits without heavy spending on exploration and development.
Now, with the cost of producing a barrel of oil in the mid-teens, oil companies are spending again. Chevron, for example, is leading a joint venture developing a huge find in Kazakhstan’s Tengiz oil field, which some industry analysts estimate could be the most significant find in the last 30 years. Chevron estimates the output from the Tengiz field will rise to 260,000 barrels per day this year and to 700,000 bpd by the end of this decade.
But no matter how fast new discoveries are developed, existing wells are drying up faster. By the end of the decade, energy consumers will have to find ways to use other fuels — like coal or natural gas — to keep up with growing demand, according to Adkins.
“Twenty-five years from now you’re not going to be using nearly as much oil as you’re using today,” he said.
Reuters contributed to this story.