OPEC: The pressure rises - Financial Times, September 22
Robert Corzine explains why Opec members, facing
demands to loosen oil production constraints, have to
prove they can work together in the good times as well
as the bad
The senior official from a member of the Organisation of
Petroleum Exporting Countries stood beside his blue
Bentley one evening this month and pulled a miniature oil
price monitor from the pocket of an immaculately tailored
suit.
He smiled as the electronic device came alive, glowing
with the news that Brent crude oil futures - the market's
estimate of the likely price of oil in two months' time -
had risen above $23 a barrel. The price was a 32-month
high, a remarkable upswing since the low of just above
$10 last February, the culmination of two years of falling
prices due to oversupply.
"Last year, the longs got screwed," said the official
softly, referring to speculators who bet against the price
of oil falling to its lowest real level since the early 1970s.
"This year, we'll screw the shorts."
As oil ministers from the Opec countries gather in
Vienna today to review a series of production cuts made
over the past 18 months, they may - at least privately -
feel a similar sense of power.
The past few months have proved one of the more
successful periods in the history of Opec's attempts to
control the oil price. Not only have its member countries
largely stuck by the production cuts - and avoided the
past practice of "quota cheating" - but non-Opec
members have been unable to take up the slack. Helped
by the oil price speculators that its officials disdain,
Opec has emerged from a traumatic period.
In recent weeks, the cartel's members have watched with
amazement as the oil price has risen to levels that some
believe are unsustainable. "If they are stupid enough to
give it to us, then we'll take it," says one Gulf oil
producer philosophically.
Yet higher prices carry a cost: pressure from inside and
outside the cartel to reverse its current production
constraints. Oil companies that were forced into mergers
by the earlier price fall remain sceptical about higher
prices being sustained. But if prices remain high - or rise
further - it could have serious inflationary consequences
for western economies, including the US.
Opec's critics warn that prices could rise sharply if oil
stocks fall further in the run-up to winter. They say Opec
ministers must agree now to release more crude oil if
they are to avoid a further upward spike. As these
external pressures grow, internal divisions have also
emerged on whether Opec should try to moderate prices
now, or wait to make sure that past surpluses of oil have
been eliminated.
Last week Hugo Chavez, Venezuela's president, said oil
prices were high enough. Venezuela wants Opec to set
a broad band in which it would defend prices by adding
or cutting output - although its proposal has gained little
backing. Other Opec members, including Saudi Arabia,
the world's biggest oil producer and exporter, say Opec's
actions should be linked to the level of global crude oil
stocks.
The problem faced by Opec is that accurate data about
oil inventories remain scarce, in spite of efforts to
compile them by companies, government agencies and
industry consultants. Neither is the oil price itself as
reliable a guide as it used to be, since price turns tend to
be magnified in the short term by futures trading.
In practice, most oil industry experts believe that global
crude stocks are still at relatively high levels in spite of
Opec's cuts. That has led some Opec member states to
advocate an extension of the present production
constraints beyond March.
They fear the consequences of increasing output in the
second quarter of next year, when world oil demand is
usually at the low point in its annual cycle. "There is an
inclination towards [freezing production] because any
increase in output in March would be the most
dangerous thing we can embark upon ahead of the
summer," says Sheikh Saud Nasser al-Sabah, Kuwait's
oil minister.
Such views make it unlikely that Opec ministers will
move immediately towards relaxing production
constraints. Yet the outlook for the oil price depends on
a number of factors that are ultimately outside the
collective control of ministers. First, and perhaps most
important, is the question of whether Opec can maintain
its newfound discipline, or whether quota cheating will
break out among its members.
So far this year, the usual suspects within Opec have
been on their best behaviour. This is certainly true of
Venezuela, where the new government under Mr Chavez
has overturned the approach of its predecessor. Before
Mr Chavez, Venezuela had openly flouted Opec quotas
and was trying to engineer a huge increase in production
capacity by inviting foreign companies to develop new
fields.
Venezuela's short-term ability to cheat is also being
undermined by government-ordered investment cuts at
Petroleos de Venezuela (PDVSA) the national oil
company. Unlike the big Middle Eastern producers,
whose large output comes from a relatively small number
of wells in a few giant fields, PDVSA needs constantly to
drill new wells on its many small fields in order to sustain
production. Some oil executives believe Venezuela may
even struggle to fill its Opec quota in 2000-01 unless
more investment is directed towards its domestic oil
production industry.
The fact that Mexico, another Latin American producer
and a fierce competitor of Venezuela in the lucrative US
oil market, is co-operating with Opec's production
restraint pact has given Caracas added confidence that
sticking with the cuts will not leave it at a commercial
disadvantage.
Iran has also fallen into line, in part because of this
year's diplomatic rapprochement with Saudi Arabia, while
civil unrest in Nigeria's oil-producing region in the Niger
Delta has left it with little leeway for quota busting. Iraq,
whose steady production build-up of recent years under
the United Nations oil-for-food programme was another
cause of last year's price fall, is nearing the end of what
it can do without foreign investment in its industry, which
is being discussed at the UN.
The second factor determining the oil price is demand.
Here, too, the macro-economic outlook appears
generally positive for Opec. There are signs of economic
recovery in Asia, which in spite of its recent financial
problems remains the region where oil demand growth is
expected to be greatest in the coming decade. A
continuation of the strong economy in the US, the
world's biggest oil market, also bodes well. There are
other factors that could support demand for oil: many
refineries worldwide may boost their crude oil stocks in
coming months in order to avoid any Y2K-related supply
disruptions, while a return to normal winter temperatures
in the northern hemisphere after two mild winters would
help consumption.
Third, there is the question of how quickly non-Opec
members - such as the UK and Norway - will be able to
raise output to take advantage of higher prices. Last
year's low prices forced some operators in higher-cost,
non-Opec regions to stop production at low productivity
wells, in some cases permanently. Drilling activity in
non-Opec areas remains at relatively low levels, since
many oil companies are still smarting from the effects of
the oil price fall.
Many of the west's biggest oil companies have also
reined in capital expenditure. More than a few are
sceptical about how long crude oil prices will stay at
present levels and have, so far at least, not relaxed strict
investment hurdle rates imposed during the collapse.
Mark Moody-Stuart, chairman of Royal Dutch/Shell, the
Anglo-Dutch oil group, recently warned that Opec could
easily reverse its present policy and send prices
tumbling again in order to discourage a new round of
investment in higher cost, non-Opec regions. He also
noted that even small changes in Opec output can have
a big effect on prices, given that sentiment and
perceptions play such a role in oil markets.
Some commentators, such as the Centre for Global
Energy Studies in London run by Sheikh Zaki Yamani,
the former Saudi oil minister, believe the price rise is
eventually bound to stimulate higher output from
non-Opec members. "As night follows day, high prices
lead to slower demand growth and more non-Opec
supplies," the centre says. That view, however, is
disputed by other experts, who believe that non-Opec
producers no longer have big enough reserves to take
advantage of Opec's production cuts, and capture a
larger share of the world oil market.
But if the ministers in Vienna can this week bask in their
resurgent power, the damage wrought by last year's
price collapse will be fresh in many of their minds. The
US government's Energy Information Administration
estimates that Opec oil revenues this year will be about
$123bn, nearly $24bn more than in 1998. But in real
terms that is less than a quarter of Opec revenues in its
peak earning year of 1980, when the populations of many
member states were substantially smaller.
Ministers would also be wise to remember that success
has traditionally been a rather fleeting experience for
Opec. A number of political and economic factors have
converged this year to enhance the prospect that oil
prices will remain firm in the short term. But Opec has
rarely been able to sustain such successes for long.
"Opec should consider changing its logo to a tea bag,
because it only works when it's in hot water," says
Robert Mabro, director of the Oxford Centre for Energy
Studies. The challenge for Opec's oil ministers this week
is to prove that it can function effectively in good times
as well. Only then will it be able to punish those
speculating against higher oil prices as effectively as
some officials believe. |
