OPEC Cuts Oil Production but Skepticism Abounds
In yet another effort to support oil prices, which have fallen 29% over the past
year, the Organization of Petroleum Exporting Countries (OPEC) and other
producers pledged recently to further cut production by 1.38 million barrels per
day. These cuts, effective July 1, are the second round of reductions pledged this
year and bring the total amount of cutbacks in 1998 to more than 3.1 million
barrels per day. While these reductions might seem impressive, analysts remain
concerned that they might not be enough to alleviate the global oil glut, estimated
at more than 200 million barrels, which was brought about by a combination of
an unusually mild winter in the Northern Hemisphere and the Asian economic
slump.
Complicating the issue is that the markets have become skeptical of OPEC's
promises due to what the Middle East Economic Survey (MEES) terms "patchy"
compliance by OPEC members with the pledged reductions. A perfect
illustration of this fact is that, according to MEES, OPEC cut output by 722,000
barrels a day in April, 42% shy of its pledged target of 1.2 million barrels, as
Iran and Iraq went ahead and increased supplies. Mark Flawn-Thomas, a
money manager with Chartfield Investment has noted, "It [OPEC] is a very
loosely held alliance with the varying economic parameters of the various
members. They're not all singing off the same hymn sheet." Given this chaotic
environment, it's no wonder that the markets then sent the price of crude down
to a 12 year low of around $11.00 per barrel in early June as traders realized
that the April cuts, hampered by lax enforcement, were not reducing oversupply.
June's round of pledged reductions became increasingly urgent to OPEC
members and other producers due to the serious pinch on their economies.
OPEC's oil revenue fell to $375 million a day in May, down 29% from the $531
million in May 1997. And with most OPEC nations dependent upon oil revenues
for a large portion of their national budgets, higher prices are a necessity. Iran,
for example, relies on oil and gas exports for 80% of its total income and
Russia's energy minister estimates his country's oil producers would lose $8
billion this year if oil prices don't rebound. Mexico has cut its state budget twice
this year by a total of $2.8 billion and might be forced to do so again.
Even after the latest cuts were announced, the markets didn't respond the way
OPEC might have hoped. The price of crude has indeed rallied to the $14 range
but traders have taken a wait and see approach. Tom Bentz, senior vice
president-energy at Cresvale International, more or less sums up market
sentiment by saying that, "Talking isn't going to do anything. It's come down to
action. They have to do something about the excess supply." Brian English, a
broker with ED&F Man International, is even more blunt: "It's not enough.
People were hoping for something enormous and that didn't happen."
The issue comes down to whether or not OPEC can follow through with its
pledges, especially in the area of enforcement. Jassem al-Saddoun, an oil analyst
at Al Shall, a Kuwait-based economic research center, notes, "Agreements
amongst oil producers were possible this year because prices were so low they
were unacceptable to everyone, but what happens when the prices are painful
for some and not for others?"
There are signs that some OPEC members are finally getting the idea that
enforcement is the key to building confidence in the market. In recent weeks,
certain members of OPEC, led by Saudi Arabia, have been talking about
forming a group of seven to nine countries that will work together to raise oil
prices by cutting production. This group, comprised of Saudi Arabia, Iran, Iraq,
Kuwait, Venezuela, Mexico and the United Arab Emirates, would control more
than 70% of the world's oil reserves and almost 66% of oil exports and have the
clout needed to boost the price of oil to their aimed for target of $20 per barrel.
Will it happen? We cannot say for sure, but we believe that the recent cuts will
be better enforced.
It should take until September or October for oil glut to be erased at which point
we expect to see oil prices reaching $17 to $18 per barrel. Beneficiaries include
integrated international oil companies such as Exxon Corp. (NYSE: XON) and
Royal Dutch Petroleum Co. (NYSE: RD), though a sustained rebound in
commodity prices would be welcomed by virtually every producer. |
