Opec may consider output cut to prop up price of crude

With oil prices off nearly 30 per cent from their highs of almost $150 a barrel, Opec oil ministers are considering what was unthinkable just a few weeks ago – cutting back output to prop up the cost of crude.

No one is predicting much of a cutback – if any at all. Still, such a move would not even have been thought of with oil prices setting record after record back in July.

But the bull run appears to have paused, if not ended, which means a new look at options for tomorrow's meeting of the 13 ministers at Opec's Vienna headquarters.

Since crude surged to a record $147.27 a barrel on July 11, it has tumbled by more than $40, or more than 27 per cent. Back then, Opec's main concern was pushing back against arguments from the US and other key consumers that an output increase was needed to end rocketing prices. Oil ministers insisted there was adequate supply to meet demand, and blamed speculators and a weak US dollar for crude's stellar rise.

But now, the greenback has strengthened, world demand has decreased due to creaky economies, traders' appetites for commodities have cooled – and suddenly the market appears to have turned bearish.

Light, sweet crude for October delivery fell $1.66 to settle at $106.23 a barrel on Friday on the New York Mercantile Exchange – its lowest close since early April.

The downward spiral has led to calls from Opec price hawk Iran – the group's second-largest producer – to reduce output from the nearly 30.5 million barrels a day being pumped last month by the organisation's members.

Not far behind is Venezuela. While moderating recent demands for immediate output cuts, Venezuelan Oil Minister Rafael Ramirez has drawn the line at $100 per barrel of oil. Anything below that should serve as a wake-up call for Opec to tighten the spigots, he says – sentiment that is shared by other members.

Still, a major cutback is unlikely without Saudi compliance, and the Saudis – de-facto Opec policy setters who are now producing nearly a third of total OPEC output – have given no hint they favour that option. Saudi Oil Minister Ali Naimi has instead talked about a floor of $80 as the red line for action.

Opec has reason to be cautious. Despite their precipitous fall, prices remain 14 per cent higher this year than in 2007, and a barrel of crude still fetches four times what it did five years ago.

Any Opec move tomorrow to pare back output would send a howl of protest from the US and other major consumers, and give a larger platform to Republican presidential candidate John McCain and Barack Obama, his Democratic counterpart, to call for reduced dependence on foreign oil.

Additionally, Opec understands that high prices drive down demand and will likely try to find a balance between high profits and a price that the market can accept.

In a forecast last month, Opec predicted the world's forecast appetite for oil for this year overall will have fallen by 30,000 barrels a day and noted that world demand growth next year will be "the lowest since 2002". And on Wednesday, the US Energy Administration reported a 3.5 per cent drop for products including petrol and other oil-based products compared with last year.

Such factors have led some experts to predict Opec would opt for no change.

"The ministers will hold the status quo [although] there is going to be the usual jawboning from the usual suspects" for a cutback, says trader analyst Stephen Schork. Even now, "oil is by no means cheap and that is certainly adding a lot of pressure to the world's economies – the smarter ones, the Saudis, the Qataris the Kuwaitis are aware of this".

Others think that Opec, which accounts for about 40 per cent of world oil production, will compromise between doing nothing – thereby chancing a further erosion in prices – and slashing boldly – thereby risking skyrocketing prices and an ensuing fallback in demand.

That middle way would mean agreeing to pare away at overproduction without reducing the overall output quota of 27.3 million barrels a day set in November for the 10 Opec members under production limits.

Energy analyst Catherine Hunter of Global Insight estimates overproduction at between 600,000 and 800,000 barrels a day and says this is the likely "first target of cuts". And because most of the extra production comes from Saudi wells, such a move could be easily accepted by most Opec members.

"Ultimately, Opec wants to know what the market will bear," she writes in a recent Global Insight analysis, adding with the world's developed economies expected to perform poorly – and a resulting overspill to East Asian markets – "the answer may well be, not much".

Chip Hodge, portfolio manager with MFC Global Investment Management, also thinks that if Opec issues a call for cuts it will be in overproduction, adding the organisation has little additional wiggle room.

"Oil prices are still higher than a year ago," he says. "They just don't have much to complain about."

 

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