Red Alert [Borrowed from Oil and Gas Thread]
August 5, 1998
Kuwait and Saudi Arabia Mull Third Round of Crude Oil Production Cuts
Saudi Arabia has reportedly joined Kuwait in contemplating the possibility of a third round of crude oil production cuts, in an attempt to bolster prices. An anonymous source "familiar with official Saudi thinking" told Reuters on August 3 that Saudi Arabia may back another round of production cuts if world oil prices remain stagnant into September. The source was quoted as saying "If in September OPEC made good on its commitments [to cut output] and prices did not improve to much higher than where they are now,then Saudi Arabia and OPEC may not have to wait until [the scheduled OPEC meeting in] November" to agree on further cuts. The source reportedly refused to state Riyadh's target crude oil price.
On July 29, Kuwaiti Oil Minister Sheikh Saud al-Nasir said at a press
conference at Kuwait's National Assembly that OPEC members should consider additional production cuts if the price of Brent crude does not reach $17 by November. Sheikh Saud told Kuwait's "Kuna" news agency, "My policy is totally clear. It favors output reduction. We are monitoring the market. If prices do not improve, we shall reconsider the output quotas which were agreed recently." He suggested that a further cut of one million barrels per day may be necessary to reach price targets.
The collapse of oil prices in 1998, driven in large part by sharply reduced Asian demand, has had a severe impact on the economies of oil producing countries. In an attempt to remedy this situation, Saudi Arabia was integral in forging two rounds of production cuts between OPEC and other major non-OPEC oil exporting countries. The first agreement was brokered in Riyadh in March and the second occurred in Amsterdam in June. Together these agreements resulted in a total promised cut in production of 3.1 million barrels per day from February 1998 levels. However, this has had little effect on world oil prices. Brent crude spot prices and futures remain under $13 per barrel, $6 below the same period in 1997 and near their lowest level for 1998, and they show no sign of rising in the near future.
While there has been some cheating by signatories to the two production cut agreements, the fundamental problem with these agreements, and with any third round of cuts, is that they are simply not enough to eliminate the global oversupply. Thus far in 1998, world consumption of crude oil has averaged 74.6 million barrels per day, whereas world production has averaged 75.7 million barrels per day. The Kuwaiti-proposed additional million barrel per day cut would almost, but not quite, eliminate this surplus. That is assuming 100 percent compliance, and experience from the previous two agreements suggests more along the lines of 80 percent compliance.
On top of this, non-participants in the production cut agreements have
increased production in 1998 in an attempt to maintain revenues, and Iraq is preparing for a major increase in production. Even if an agreement could be forged to balance supply and demand, it would be some time before crude prices rose significantly, as world crude oil inventories remain glutted, Asian demand is expected to remain suppressed the next few years, and new production continues to come online.
Commercial oil inventories, which are measured in days of supply, have
increased in Organization for Economic Co-operation and Development (OECD)countries to 27.7 days of supply in 1998 from 26 days of supply in 1997.
Even with production cuts in place, global inventories are continuing to grow by 1.1 million barrels per day as refinery utilization has remained near capacity. Upward pressure on prices caused by any additional production cuts will be buffered by inventory draw-down. Furthermore, production cuts do not change the fact that Asian demand has plummeted with the region's financial meltdown, and as China gets swallowed up in the crisis, demand will only sink further.
Production cuts also fail to change the fact that new technology has made oil easier and cheaper to locate and produce. Development in some areas, such as Central Asia, has slowed due to cutbacks in national and corporate exploration and production budgets. But if prices begin to rise, these projects may resume development, threatening once again to drive prices back down. The imbalance between supply and demand, with the resulting low crude prices, looks ready to become a long-term phenomenon.
Barring an unexpected and highly unlikely recovery in Asian demand, only a dramatic, involuntary, and prolonged reduction in production has any hope of raising crude prices. One solution, reportedly suggested by Iran at the June 24, OPEC meeting in Vienna, would be for OPEC members to halt production altogether, allow inventories to decline, then resume carefully quota-governed production. This is almost unthinkable, as cheating would be inevitable and the loss in market share to non-OPEC producers would be unacceptable.
A second alternative would be to take a single major producer offline. We have argued that such a plan is already underway for Iraq. The doubling of Iraq's quota in December 1997, coupled with already surging illegal shipments, has been a major depressing factor in the world oil market.
Indeed, many Gulf States have shown growing animosity towards Iraq's
position. Kuwait and Iran have been increasingly at odds with Baghdad in the past several weeks, and appear to be making a political case for the forcible removal of Saddam Hussein. The U.S. is also once again publicly committed to the ouster of Hussein. With talks between UNSCOM and Iraq broken down, potential for an attack on Iraq has increased.
In one final note, an unconfirmed report in the Paris-based weekly
"Editor's News" on August 1 claimed that U.S. House Speaker Newt Gingrich and Senate majority leader Trent Lott have privately urged the Clinton administration to launch air strikes against the recently repaired Iraq-Syria pipeline. This report is odd, as it is questionable whether the Republican leaders would offer President Clinton a high-profile foreign policy distraction just as the criminal investigations of the Democratic President appear to be bearing fruit. But if there is bipartisan support in Washington for an attack on Iraq, Clinton would be loath to turn down such a choice political escape.
Two rounds of production cuts have failed to affect crude prices. The
Asian economic crisis is worsening, with little hope for a rebound in crude oil demand. Oil producing nations are once again looking for a solution to their economic problems. And the leader of the one world superpower, having declared a desire for friendship with Iran and for the overthrow of the leader of Iraq, is desperate to distract the media and public attention from Monica Lewinsky's dress. We have made our call. What are the alternatives?
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