IE 11 is not supported. For an optimal experience visit our site on another browser.

Will OPEC output cuts go too far?

With drivers fuming at pump prices, and politicians scrambling for solutions, OPEC is standing firm with its plan to further squeeze already-tight world oil supplies.
/ Source:

With drivers fuming at pump prices, and politicians scrambling for solutions, OPEC is standing firm with its plan to further squeeze already-tight world oil supplies. It’s not the first time OPEC has made such a move – only to see its members break ranks and quietly produce more than their quotas allow. But this time, that’s not likely. The reason: most OPEC countries are already pumping as fast as they can.

Higher crude oil prices have been just one factor in the recent surge in gasoline prices. The other big reason is that gasoline inventories – which are typically built up in the spring in advance of the summer driving season -- are lower than usual. A cold winter in much of the country kept many refineries turning out more heating oil than normal. And state-by-state environmental regulations requiring more than a dozen different blends of gasoline have produced spot shortages in some parts of the country.

“The consumer in the U.S. is going to have to get used to higher oil prices -- especially with the weak dollar," said Aaron Dunn, an investment manager at the U.S. Global Natural Resource Fund.

And with gasoline supplies so tight, it doesn’t take much to send prices higher. A fire at a major refinery in Houston Tuesday night, for example, sent gasoline prices spiking Wednesday.

“What the refinery problem (Tuesday) night shows is the price spike potential for any problem with a refinery,” said Ray Carbone, an oil trader at the New York Mercantile Exchange. "It shows you the precariousness of low gasoline stocks.”

Even if gasoline inventories rise, prices won’t come down again until crude oil prices fall. And that prospect was made less likely following  OPEC’s decision Wednesday to cut production by about 1 million barrels per day, or about 4 percent. Those cuts will begin on Thursday. The cartel’s current output target is 24.5 million barrels per day. OPEC will meet again in June to review production limits.

In the past, oil traders took OPEC threats to cut production with a grain of salt. With member countries dependant on oil revenues, overproduction has been common. Excluding Iraq, which doesn't participate in the group's quota agreements, OPEC is already exceeding its target by an estimated 1.5 million barrels.

But now, the limits of physical production capacity are imposing a more powerful cap than any formal OPEC agreement. With Iraq still producing below pre-war levels and Venezuelan production still hampered by recent strikes and political turmoil, Saudi Arabia is the only OPEC producer with any significant spare capacity.

In recent years, non-OPEC producers like Mexico and Russia have taken up some of the slack when OPEC tried to squeeze supplies. But with oil at $35 a barrel, non-OPEC producer are also pumping as fast as they can, according to Erik Kreil, an analyst who tracks OPEC production for the U.S. Department of Energy.

“At these high prices anyone that can take advantage of it is taking advantage of it,” he said. "There is no spare capacity outside of OPEC.

And with the price of a barrel of oil already in the mid-$30 range -– having briefly hit 13-year highs of about $38 -– OPEC risks sending oil prices higher still if they miscalculate the strength of demand.

OPEC’s decision to cut output was a blow to the Bush administration, which had been arguing against the cuts, and raised concerns that oil prices may be headed higher again.

“We at the IEA are concerned by the OPEC decision,” Claude Mandil, head of the International Energy Agency told a news conference in Istanbul, Wednesday. “We cannot think the market is adequately supplied.”

OPEC ministers insist that they don’t want oil prices to keep rising, saying they recognize that higher energy costs could slow the world’s economy -- which means oil producers would sell less oil. But the cartel, led by production leader Saudi Arabia, argues that since oil demand typically slows in the second quarter, the cartel needs to produce less oil now to prevent a surplus from sending prices tumbling.

In fact, crude oil inventories worldwide are slowly beginning to build -– a big reason oil prices fell $1 a barrel Wednesday after traders took a look at a weekly report on supplies. And some private analysts downplay the impact of supplies on higher prices.

“Inventories are consistent with the oil price in the high 20’s,” said Bear Stearns oil analyst Federick Leuffer, who said he agrees with Saudi officials that market speculation -– based on factors such as terrorist fears -- have pushed prices higher than they should be.

Most analysts agree that the recent spike in prices has as much to do with increased demand as with tight supplies -– especially in Asia. In the late 1990s, when Asia’s economies slumped, so did oil prices -- falling to $12 a barrel. Now, a bigger-than-expected boom in China has stretched demand for oil.

“Energy is a much scarcer resource than any of us thought because of the demand coming out of Asia,” said Ed Yardeni, chief investment strategist at Prudential Equity Group Inc.

In the meantime, the high price of crude oil and gasoline has become a major issue on Capitol Hill and the campaign trail. The Bush administration argues that Congress needs to pass a comprehensive energy bill to address the problem. But progress is stalled over provisions that have little to do with increasing supplies. One major stumbling block, for example, is a provision that would limit the liability of manufacturers of MTBE, a gasoline additive used to meet Congressionally-mandated clean air standards. MTBE, which has been found in groundwater and linked to cancer, is being phased out in many parts of the country.

Democratic presidential contender Sen. John Kerry, along with some members of Congress, have also called upon the president to suspend oil deliveries to the Strategic Petroleum Reserve, a vast underground reservoir of more than 600 million barrels, saying that suspending those deposits would ease supplies and help reduce prices.

But the administration will “stay on course” with its plan to keep filling the nation’s crude oil stockpile because it is important to national security, Kyle McSlarrow, deputy secretary at the Energy Department, said Wednesday.

The effect of filling the emergency stockpile adds “at most” 1 cent per gallon to the price of gasoline, he said.

The Associated Press and Reuters contributed to this report