Decision time

19 October 2001

Venezuelan President Hugo Chavez has made quite a mark on the oil markets since his election in December 1998. He played a pivotal role in hauling oil prices from below $10 a barrel to the upper end of the OPEC target range of $22-28 a barrel during 2000. Now, with oil prices under pressure once more, he has again taken centre-stage, visiting virtually every oil-producing country in the world. His mission is to stave off the spectre of another oil price crash. To this end he is urging OPEC to take a more realistic view on prices, and telling non-OPEC producers to take a more enlightened view of their own self-interest.

The challenge OPEC faces is that supply is outstripping demand by a wide margin, even as the seasonal upturn in demand approaches with the onset of winter in the northern hemisphere. OPEC is producing above its quota, non-OPEC countries are increasing capacity, and demand is being depressed by the global economic slowdown.

The OPEC October Monthly Oil Market Report (MOMR) shows non-OPEC supply growing by 1.3 per cent over 2001 to 46.4 million barrels a day (b/d) and by a further 2.2 per cent over 2002 to 47.4 million b/d. Demand will fall by 0.6 per cent in 2001 and grow by just 0.8 per cent next year, according to the October MOMR.

There is a clear need for a production cut, either through a reduction in the official OPEC quota, or through tightening members' compliance with the existing ceiling. But OPEC has already slashed its nominal output by 3.5 million b/d since January to little effect, and it is fast approaching an unpalatable decision: will it continue to cut production to defend a sliding price, or will it reconsider its target?

Open debate is muted, but there are signs that, within the organisation, all options are being considered. 'In a rational calculation, and we have no interest in pushing prices up beyond what we consider a fair price, the band could be between $18-22 a barrel,' said Chavez on 19 October. 'It is part of the recalculations which are going on in OPEC countries and non-OPEC countries.'

The statement echoes similar hints made by OPEC ministers throughout the year, but other members swiftly refuted talk of an alteration. 'I don't think we need to change the band,' said Iranian Oil Minister Bijan Zanganeh on 21 October. 'Most of the OPEC members believe that it is a good range and we don't want to change.'

Kuwait, which has itself been reported to support a measure of flexibility in the band, put forward a moderating view. 'The government of Kuwait looks forward to reaching a price in the lower half of OPEC's price range,' said Oil Minister Adel Khaled al-Sabeeh after Chavez's comments.

The price band of $22-28 a barrel was agreed upon as the organisation developed a cohesive strategy to revive the market following the 1998 price slump and improved its compliance to quotas. The performance impressed many traders and analysts who had written off OPEC's commitment to a single target and its ability to pursue it. Yet they have been quick to point out that the climate has changed considerably since the summer.

'In the two years since the price slump, it's been easy to be disciplined,' says Sarah Emerson of the US' Energy Security Analysis (ESA). 'But the market fundamentals are shifting now. Non-OPEC production is growing, OPEC market share is falling and the price is lower. They've done a great job so far, but it's getting harder.'

The priority must be to crack down on poor compliance with the existing output ceiling. 'There's a perception that OPEC can't curtail supply, and that is driving prices down,' says Manouchehr Takin of the London-based Centre for Global Energy Studies. 'Before it takes any other action, it must put its own house in order to get some credibility.'

OPEC is unable to admit to overproduction, estimated at 1.1 million b/d in September, but the topic is understood to have dominated most meetings between members in the third quarter. 'We've been in contact, closing ranks, standing square in defence of the prices of oil,' said Chavez on 19 October, indicating that the organisation is tightening its belt.

'I think OPEC can come down to the 23.2 million-b/d ceiling,' says Emerson. 'But my guess is it won't get there in November or even December. Getting close to the target will do a lot for prices, but there will be fresh difficulties in the first quarter when demand slips again.'

In the effort to rein in oversupply, urgent appeals have been made to non-OPEC producers. 'We wouldn't achieve much if OPEC cuts production and other, non-OPEC countries increase production,' said Chavez. 'We need to close ranks with Russia.' A meeting was due to be held on 29 October between OPEC and non-OPEC officials to find a common ground on prices. Russia, Mexico, Oman and Kazakhstan were expected to attend as well as some other producers, not including Norway. The central OPEC demand is for a moratorium on new output additions.

'Some ministers have said that they need non-OPEC producers to join with the production cuts,' says Takin. 'However, if you combine that with the poor discipline in OPEC now, the psychological impression is of weakness. OPEC wants to reverse this and it's true that most producers want a higher price. It will increase its own discipline and bring in the other producers to avoid prices falling below $17-18 a barrel.'

The option of cutting quotas has been discussed too. Saudi Petroleum & Mineral Resources Minister Ali Naimi in early October indicated that a cut of between 700,000 b/d and 1 million b/d was on the cards.

Chavez, too, is speaking more firmly about an impending cut, indicating that the largest producers are drawing towards a decision. 'If necessary, we will make a fresh cut in oil production,' he said on 22 October. 'We are ready to do it, so is Saudi Arabia, so is Iran and Algeria and Libya too.' Clear as the message seems, OPEC has before signalled cuts that never came, aiming to give a short-term boost to prices while the market picked up. It is far from clear whether, or when, a new quota cut will be made, but most producers will want to have made a decision before the next OPEC meeting on 14 November.

The danger high output presents to all producers is that stocks will continue to grow, bolstering supply and lowering prices for months to come. However, US crude inventories registered a sharp fall of 7 million b/d in mid-October, reversing a trend of stocks growth that had persisted throughout the previous month. Analysts say there are also signs of reductions in the flow of oil to Asia. But supply still significantly outstrips demand.

As the winter season of higher demand growth takes effect, albeit partly reduced, OPEC will be given some respite from its dilemma. However, potential political flashpoints still lie in ambush on the path ahead. The war in Afghanistan is most likely to remain limited, but the question of Iraq poses a perennial problem.

Baghdad imposed a total oil export moratorium throughout June in protest at the sanctions programme. More trouble is expected when the oil-for-food programme comes up for renewal at the start of December. The US and UK will once more try to impose the smart sanctions proposals that were shelved in June, but this time the tactics will differ to reflect the new political reality. Russia, which opposed the move last time, is now expected to present less opposition to smart sanctions. France will try to offer an alternative solution and roll over the existing sanctions regime but accommodate some of the changes proposed by the US.

The chances are that Iraq will protest vigorously and use the high political tension of the moment to amplify its voice with another export cut. However, oil supply is strong enough to limit the effect of such a move, with OPEC commanding spare capacity of at least 6 million b/d.

In the short term, prices are set to remain at about $20 a barrel. ESA's Emerson puts Brent prices in 2002 at $19.50 a barrel, while Washington-based Petroleum Finance Corporation has it at $20 a barrel. If OPEC can bring its production down to its stated level and persuade non-OPEC producers to freeze their expansion programmes, prices can be held at, or slightly above, the present level for the foreseeable future. However, if it announces a production cut without proving it can carry it through, it faces a real danger of losing its credibility and making any future action look irrelevant.

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