Tough decisions ahead for Opec

Oil producers’ group, Opec meets today for the first time in 2011, with Brent crude oil prices once again approaching $120 a barrel.

At $117.18 a barrel, Brent crude, the reference price for more than half all global oil transactions is some 30 per cent higher than the 2010 average of $84 a barrel.

The US’ West Texas Intermediate (WTI), however, has dipped below $100 a barrel again to $98.19 a barrel widening the premium between the two benchmarks to $18.99 a barrel.

Last time the twelve members met in Vienna on 11 December, the gap was less than $2.

The latest projections from the Paris-based International Energy Agency (IEA) suggests average 2011 oil demand will only be 89.2 million barrels a day (b/d), lower than the fourth quarter 2010 rate of 89.4 million b/d.

However, hedge funds and large speculators continue to believe that oil prices have further to go.

 “But in the end, fundamentals will always prevail”, says Paul Hodges on his blog, Chemicals and the Economy.

Absent geopolitics or similar, we are probably at a tipping point, says Hodges.

Opec and Saudi Arabia in particular, have plenty to lose from prolonged high prices.

“These support much greater use of renewables, as Saudi Oil Minister [Ali al-Naimi] noted last November, and so pose a real threat to the long-term demand for oil on which Saudi’s economy depends”, Hodges explains.

Petrochemical companies, which are at the mercy of their feedstock prices were forced to buy forward early in the year to preserve their margins from the increasing prices. The focus is now on the risk of demand destruction being triggered by a prolonged period of high prices.

“Opec which holds most of the current global spare capacity therefore has to tread a fine line between optimizing their revenues without damaging the economic recovery”, says Ole Hansen, a commodity analyst with Denmark’s Saxo Bank, in a research note on 8 June.

The loss of some 1.4 million b/d of production from Libya has prompted Opec, and in particular Saudi Arabia to increase production above their stated target by approximately 1.3 million b/d.

The group now has some interesting decisions to make. Extra supply means even lower spare capacity, reducing the group’s ability to manage any further supply shocks.