OPEC price ceiling bust open by war fears

04 October 2002

Iraq war jitters have raised the OPEC basket price above the organisation's target of $22-28 a barrel. On 1 October, the basket was valued at $28.50 a barrel. Declining stocks in the US, storms in the Mexican Gulf and OPEC's late-September decision to keep output levels unchanged have also bolstered the price. Apart from a brief spell immediately after 11 September, the oil price is higher than at any point since early 2001.

The main driver of oil prices at present appears to be market perceptions of the likelihood of conflict breaking out in the Gulf, and of the implications that would have for supplies of crude from the region. Because of the sentiment-driven nature of the market at present, OPEC has been reluctant to boost supplies.

Under a mechanism agreed by OPEC in late 2000, the organisation will automatically increase its production by 500,000 barrels a day if the oil price stays above $28 a barrel for more than 20 consecutive days. However, OPEC decided not to use the mechanism to reduce its production when the price was under the target floor for two months late last year, and it is doubtful it will use it now. At its 19 September meeting, OPEC insisted the price was artificially high because of war fears, but that the mechanism was intended to address market fundamentals.

There are some signs the high prices could be short-lived. Apart from the prospect of much higher Iraqi production and exports after a possible war, the danger of military conflict could seriously stunt the world economic recovery, harming oil demand. Production is also rising strongly elsewhere, with Russian and West African producers leading the rush to capitalise on OPEC's work in pushing up oil prices.

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