Global Insight Perspective | |
Significance | OPEC has announced a decision to cut output for the first time in more than a year. |
Implications | With prices falling by over US$40 per barrel in less than eight weeks since the highs of mid-July, OPEC is anxious to put a stake in the ground and start marking out a price floor. The move is a cautious first step in defence of prices, and while it should help to slow the pace of the oil price decline, it is not likely to be enough to reverse the current price direction. |
Outlook | OPEC will closely watch the impact of this cut to assess its next step. It is more than likely that further cuts will be required before the price reaches a floor. |
OPEC Surprises with Quota Decision, But Outcome Is As Expected
OPEC’s decision to go back to the future on quotas came as something of a surprise, but the overall effect (cutting 500,000 barrels per day, b/d, of production) is in line with expectations. In a statement released in the early hours this morning, OPEC agreed to abide by September 2007 production quotas, with adjustments made due to the exclusion of Indonesia and Iraq, and the additions of Angola and Ecuador. Member countries were urged to strictly comply with the quotas, which OPEC stated at 28.8 million b/d overall. Once again, OPEC did not publish specific country-by-country targets, but form OPEC’s statements it appears that the move reinstates the 27.25-million-b/d target that was published (briefly) in September last year, with the subtraction of Indonesia (leaving OPEC) and the addition of Angola and Ecuador (which formally joined OPEC at the end of 2007). Overall then, this amounts to a cut of 500,000 b/d by Saudi Arabia, which in May and then June announced unilateral output increases of 300,000 b/d and 200,000 b/d respectively. Latest estimates have put Saudi production at approximately 9.5 million b/d compared to the September target of 8.94 million b/d.
Expectations prior to the meeting were that OPEC would unofficially trim back production levels that had unofficially increased over the course of the last few months as the Saudis responded to prices that had risen in excess of US$140 per barrel (/b). The reference to September 2007 quotas was rather unexpected, but actually amounts to much the same. What is curious once again is OPEC’s refusal to publish country-by-country targets. In September last year they did publish these targets, but they only remained on OPEC’s Web site for one day, before being taken down. Prior to this the last official country-by-country targets were published in 2005. It does suggest there may be some internal questions over the country allocations that are still not resolved. In assessing the numbers based on the September 2007 publication however, it appears that the change simply removes Indonesia from the quota system. If the Saudis retract the May and June output hikes, that will bring OPEC back in line with the September 2007 quotas.
Targets and Estimates (mil. b/d) | ||
Country | September 2007 | IEA-Estimated |
Algeria | 1.36 | 1.38 |
Angola | 1.90 | 1.90 |
Ecuador | 0.52 | 0.50 |
Iran | 3.82 | 3.97 |
Kuwait | 2.53 | 2.63 |
Libya | 1.71 | 1.68 |
Nigeria | 2.16 | 1.97 |
Qatar | 0.83 | 0.88 |
Saudi Arabia | 8.94 | 9.50 |
United Arab Emirates | 2.57 | 2.66 |
Venezuela | 2.47 | 2.36 |
TOTAL OPEC 11 | 28.81 | 29.43 |
Iraq | - | 2.47 |
Indonesia | 0.87 | 0.86 |
TOTAL OPEC 12 (+ Indonesia) | 29.68 | 32.76 |
IEA = International Energy Agency | ||
OPEC Acts to Put a Floor Under Prices
This decision comes in response to the rapid fall in crude oil prices, which have tumbled from a peak of US$147/b in July, to a low of just over US$100/b yesterday. The speed of the fall has alarmed OPEC, and with demand growth forecasts being trimmed back due to a more pessimistic outlook for the global economy, OPEC is concerned about possible oversupply in the market, and is eager to establish a price floor. Aside from the weakness in prices, there has yet to be tangible evidence of this over-supply in the market turning up in rising inventories, but stock data do lag production. Global Insight estimates suggest that there may be a surplus of production in the fourth quarter of over 1.5 million b/d without OPEC taking any action on output. Given growth in non-OPEC supply over the next six months and weakening demand, the figure rises to over 1.7 million b/d by the second quarter of 2009, even with a 1-million-b/d OPEC production cut included. While OPEC will take some criticism for a decision to cut back on production with prices over US$100/b, the decision to trim excess capacity does appear to be warranted by the fundamentals. The rather muted impact of this move on prices (so far) further suggests that the decision is not enough to counter the bearish market mood.
Oil prices yesterday weakened throughout the day as speculation that OPEC would take only limited action on supply increased. Prices fell despite concerns over Hurricane Ike, which has now entered the Gulf of Mexico and is threatening to gather strength as it approaches the U.S. Gulf Coast. The bear market shrugged off the latest weather concerns, however, as New York Mercantile Exchange (NYMEX) crude dropped US$3.08/b by the close of trading to end on US$103.26/b. In London, IntercontinentalExchange (ICE) Brent ended the day on US$100.34/b, having briefly dropped below the US$100/b in intra-day trading. Prices did move higher following OPEC’s announcement in overnight trade, but have again weakened, with NYMEX crude up just US$0.11/b in early trading today from yesterday's closing price.
Outlook and Implications
OPEC’s decision will help to firm up oil prices over coming weeks, but is unlikely to be enough to reverse the downward price trend. What OPEC has done is signal to the market that oil is now approaching a price level close to the minimum that will be accepted. Iran and others have talked about establishing a price floor at US$100/b, but this move suggests that the organisation would be willing to see prices drift lower, particularly given the weak global economic outlook. Further action from OPEC is likely to come no later than the first quarter of 2009 given the current market balance, though the usual provisos about supply disruptions apply as ever. However, one further aspect of this move is that it does significantly increase the amount of spare capacity available. This in itself will go some way to reducing any price premium on oil due to geopolitical risks. The spare capacity figure is still some way off the levels enjoyed for most of the past three decades, but it is rising again, and will continue to rise through 2009.