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OPEC cuts oil production but world demand is still rising

October 24th, 2008 · No Comments

OPEC is playing a dangerous game with the world economy as falling energy prices were one of the few bright spots.

OPEC Agrees to Cut Production Quotas as Price Slumps (Update2)
By Maher Chmaytelli and Margot Habiby

  • Oct. 24 (Bloomberg) — The Organization of Petroleum Exporting Countries cut oil production targets for the first time in almost two years to stem a collapse in prices.
  • OPEC decided to lower supply by 1.5 million barrels a day from November, oil ministers said today at the end of a meeting at the group’s Vienna’s headquarters. The reduction will be from the existing quota for 11 members of 28.8 million barrels a day.
  • “Demand is significantly less than what is being supplied, that is the reason the cut was taken,” Saudi Arabian Oil Minister Ali al-Naimi said after the meeting. Crude oil has tumbled 57 percent from a July 11 record of $147.27 a barrel as the financial market crisis spreads, job cuts increase and fuel consumption slows. Prices fell as much as 7.7 percent today.
  • “OPEC has offered the market all the ammunition they had,” said Robert Laughlin, senior broker at MF Global Ltd. in London. “With the bearish economic outlook and manufacturing in freefall this accord is not good enough.”
  • OPEC President and Algerian Oil Minister Chakib Khelil said at a news conference that the cut will be “100 percent effective” in stabilizing prices.
  • U.K. Prime Minister Gordon Brown is “disappointed,” his spokesman told reporters in London. “We’re concerned by the decision. OPEC has a crucial part to play in the stability and recovery of the world economy.”
  • IEA Forecast
  • The International Energy Agency said Oct. 10 that demand among industrialized nations will fall 2.2 percent this year, reducing overall world demand growth to 0.5 percent.
  • Khelil said global demand will grow by 400,000 barrels a day this year and 700,000 barrels a day in 2009, and an increase in non-OPEC production is expected to take care of the greater consumption.
  • Saudi Arabia, the group’s largest producer, will reduce its output target by 466,000 barrels a day. Iran, the second- biggest, will cut 199,000 barrels, OPEC said in a statement. Kuwait’s share of the reduction will be 132,000 barrels, the United Arab Emirates 134,000 barrels and Venezuela 129,000 barrels.
  • The specific country-by-country cuts are constructive; the markets tend to equate details with serious intent,” said Mike Wittner, London-based head of oil-market research at Societe Generale SA.
  • Another Cut
  • Another cut in December is “possible,” depending on how the oil market reacts, Qatari Oil Minister Abdullah bin Hamad al-Attiyah said in an interview after the decision. The producer group is scheduled to convene in Oran, Algeria, on Dec. 17.
  • Addison Armstrong, director of market research at Tradition Energy in Stamford, Connecticut, said in an interview in Vienna that a further reduction of 500,000 barrels a day is possible.
  • “If prices continue to fall, they may find themselves having to revisit deeper production cuts,” Armstrong said.
  • Al-Naimi said there was no need for a further cut yet. Conversely, should prices rally again, OPEC would consider raising production, the Saudi minister said.
  • Oil for December delivery dropped as much as $4.99, or 7.4 percent, to $62.85 a barrel on the New York Mercantile Exchange after OPEC announced its decision. Crude was down $3.21, or 4.7 percent, at $64.63 a barrel at 10:01 a.m. in New York.
  • Price Levels
  • Saudi’s al-Naimi rejected a suggestion put forward by Venezuela that the group re-establish a target price range. OPEC nations use different price assumptions in their government budgets and the group abandoned a range of $22 to $28 a barrel several years ago.
  • “I just wish they would say what price they want,” John Hall, managing director of John Hall Associates Ltd., said today in an interview in Vienna. “Is it $60, $80 or $90?”
  • At a meeting last month, OPEC urged greater compliance with existing quotas, saying that would reduce supply by about 500,000 barrels a day. OPEC members excluding Iraq and Indonesia last month pumped 390,000 barrels a day more than their combined quota of 28.8 million barrels a day, according to Bloomberg estimates.
  • The last time OPEC decided to slash official quotas was at a December 2006 meeting in Abuja, Nigeria. The 500,000 barrel-a- day cut took effect in February 2007, expanding an earlier reduction agreed in October. The cuts were reversed later in 2007 as oil rallied.
  • Historic Mistake
  • Eleven years ago, OPEC members bickered about output quotas as oil slid 28 percent in 10 months amid the onset of the Asian financial crisis. At a meeting in Jakarta in November 1997, they raised quotas, ignoring the turmoil that slowed Asian economies and cut oil demand. Prices fell another 44 percent by December 1998 to below $11 a barrel.
  • “The important thing about this meeting is that it shows they have the resolution and cohesion to deal with the downturn in demand and not repeat the mistake of the Asian crisis,” David Kirsch, an industry consultant at PFC Energy said today in an interview in Vienna.

A couple of interesting points:

  1. Most importantly for us is the fact that world oil demand is still rising this year and next, despite all the economic troubles. This is something we have said a couple of times, demand for commodities in general is less affected than investment in facilities (drilling, infrastructure, plants, etc.) to increase supply, and this will set us up for much higher prices when economic conditions improve, as they invariably will.
  2. The oil prices reacted negatively to the announcement, making another cut in production more likely.
  3. It’s a bit of a daring game with the world economy, one of the few bright spots were the deep falls in commodity prices, easing demand destruction somewhat and, more crucially, enabling central banks to lower interest rates as inflation fears have subsided.
  4. OPEC could risk too much, curtailing production too much is a dangerous game with the world economy.
  5. The dollar is rising like there is no tomorrow, in part this is related to the falling oil prices, which is seen as bullish for the dollar, in another part it’s related to the perception that the European Central Bank (ECB) will be lowering interest rates further, which they only can do as a result of the falling oil prices. The rising dollar is part compensation for the fall in oil prices for the oil producing countries

Tags: Commodities