OPEC cuts only a
short-term solution
By Stephen Wyatt
A pragmatic OPEC, scrambling to stop the collapse in
global oil markets, is expected to ratify its recently
announced reductions in oil production of 2 million
barrels at its March 23 meeting in Vienna.
This news has already buoyed market sentiment and the
oil price rallied 9 per cent last week.
But many analysts suspect that an OPEC production cut
will go nowhere near solving the oil market's long term
problems.
OPEC's pragmatism has come too late.
"Oil markets may well be heartened by the prospects of
additional OPEC production cuts, but the outlook
beyond March remains less comforting," said Damien
Hackett and Gary Lampard, commodities analysts at
CSFB in Melbourne, in a recent research paper.
Big structural changes are occurring in the oil market. The
global oil industry is in the midst of its most profound
structural change since OPEC discovered pricing power
in the 1970s, say Hackett and Lampard.
OPEC no longer commands the dominating position in
the oil market that it had back in the 1970s. Oil has
become "re-commoditised and de-nationalised" and the
market has become increasingly competitive with
ballooning non-OPEC production.
The consequences of OPEC's pricing power are now
coming home to roost. By driving the oil price up in the
1970s, exploration and development outside the Middle
East boomed along with the development of alternative
energy sources.
OPEC's pricing power steadily slipped along with its
share in global oil production. OPEC's share has fallen
from about 55 per cent in 1973 to just 40 per cent today.
And OPEC's impotence has been highlighted by Asia's
economic collapse. An oil glut has developed and the oil
price has halved over the past two years.
But rising competition and structural change is not just an
oil story. It is also a story that covers a range of
commodities - from coffee, cocoa and sugar to gold,
grains, wool and metals.
The power of the market has overtaken institutionalised
forms of marketing. Witness the collapse of the
International Sugar, Coffee, Cocoa and Tin Agreements,
the end of Australia's Wool Reserve Price Scheme and
hefty price support in the gold market by the world's
central banks, and now the unravelling of European and
US price support schemes for agricultural commodities.
Competition has hit the commodity markets.
Some dinosaurs still exist, like Australia's myriad of
agricultural statutory marketing boards from the
Australian Wheat Board through the NSW Grains
Board, NSW Rice Growers Co-operative and the
Australian Barley Board to Queensland Sugar.
But it is only a matter of time before Australian growers
realise that the espoused OPEC-like benefits claimed by
the agripoliticians of their boards, just do not exist in
today's world.
Oil tells the story well. OPEC ruined itself.
But OPEC could also rejuvenate itself. The rub is that it
can only do so by allowing the oil price to fall even
further. Last weeks Economist magazine talked of
$US5/barrel oil.
The reason is that, while OPEC has currently lost its
market power, it still owns the bulk of the world's
unexploited reserves which are also the reserves with the
lowest development and extraction costs of around
$US2/barrel.
This compares to exploration, development and
production costs in South East Asia of $US6/barrel,
Venezuela and West Africa $US7/barrel, Gulf of Mexico
$US10/barrel, North America and North Sea
$US11/barrel and former Soviet Union $US14/barrel.
Saudi Arabia has about 25 per cent of the world's
proven reserves, Iraq 10.8 per cent, the UAE 9.4 per
cent, Kuwait 9.3 per cent and Iran 9 per cent.
These oil dependent countries are desperate to increase
oil revenues in order to fund rising budget deficits. They
can do this two ways; either by increasing the oil price or
increasing exports.
Under current market conditions increasing prices is a
tough task. "OPEC is becoming just another price taker,
and the economics of the oil market today are not
conducive to higher prices," said Damien Hackett.
At the same time, non-OPEC producers are not
aggressively reducing output, despite the low prices,
because very few, especially those in softer currency
countries like Australia, are actually losing money. Even
in the North Sea some cash costs have fallen to less than
$US5/barrel.
Rapid technological advances in exploration and
production has pushed the average supply cost of oil
outside the Middle East down to about $US10/barrel,
compared to $US20-30/barrel in the 1980s.
Clearly, with announced total cuts of now over 5 million
barrels/day, OPEC is still trying to boost the oil price
rather than redominate the market. But if this fails, the
taps may be thrown open.
According to Jeremy Elden, of Commerzbank in
Germany, quoted in The Economist, the logical path for
OPEC is to pump as much oil as it can. After a period of
lost revenues, he argues, at a price of US$10/barrel "the
Gulf states would enjoy years of strong cash inflow as
they take market share from high-cost regions ..."
afr.com.au
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