Producers' Pact to Cut Supply
Of Oil Is Unlikely to Succeed
By STEVE LIESMAN, JONATHAN FRIEDLAND and THOMAS T. VOGEL JR.
Staff Reporters of THE WALL STREET JOURNAL
March 15, 1999
After a 13-month downturn in oil prices and squabbling among the world's producers, last week's agreement to cut world petroleum supplies suffers from a credibility problem.
Skeptics contend that Friday's decision by major oil-producing nations to reduce world supplies by two million barrels a day looks doomed to fail. The only question, they say, is how quickly the agreement will collapse.
On the one hand, they expect cheating by producers, who could find it hard to keep their oil off world markets amid higher prices. In addition, higher prices allow higher-cost production to come back on line, which could start the oversupply cycle once again.
"The old reality will dawn again," says an official from the Organization of Petroleum Exporting Countries, who insisted on anonymity. "People will start producing more, lots of production you have taken out will come back and delays on production from non-OPEC sources will be lifted."
A Question of Discipline
At the heart of the skepticism is the question of whether the 40-year-old OPEC cartel, even in concert with some non-OPEC producers, such as Mexico, can really discipline the market the way it used to. OPEC controls only about 40% of world production, and the agreement will reduce that share. Meanwhile, new technology, greater availability of capital and the creation of even bigger oil companies as a result of recent mergers means that non-OPEC supply, after its recent dip, should rebound fairly quickly.
"There has been only some permanent loss [of non-OPEC production]," says Leo Drollas, chief economist with the Centre for Global Energy Studies. "In a year's time, prices will be weak again."
Add to that the vagueness of the accord, in which oil officials from Venezuela, Saudi Arabia, Mexico, Algeria and Iran agreed on a formula for world producers to cut output by about 2.6% of global production of 75 million barrels a day. The accord, which is for one year beginning April 1, is subject to approval at the OPEC meeting in Vienna next week.
Saudi Arabia, the world's largest producer, is believed to have consented to cut its output by 500,000 to 600,000 barrels daily, taking it below the eight million barrels a day which it has tried to defend for the past several years. Iran, a perennial cheater on such agreements, is reported to have committed to reduce production by about 200,000 barrels a day. Kuwait's oil minister said over the weekend that his country would contribute cuts of about 140,000 barrels a day.
Mexico, as it did in similar agreements struck last year, has promised to cut exports, not production, and is committed only through December, when the government's fiscal year ends.
Doubtful Promises
The contribution of other OPEC and non-OPEC members is unclear. Many of the most economically troubled producers, such as Indonesia and Russia, have a history of promising cuts that aren't delivered.
To be sure, many analysts see the accord fueling higher prices, at least in the short-term. Futures prices of West Texas Intermediate Crude for April delivery gained 18 cents on the New York Mercantile Exchange Friday, to close at $14.49. Prices this year had fallen as low as $11.35 a barrel in mid-February. Some of the cuts, particularly from Saudi Arabia, the most reliable party to such agreements, will certainly be felt in the markets.
Saudi Oil Minister Ali Naimi warned skeptics not to be too sure about cheating. "Compliance is going to be very high from now on because of this agreement," he said. "There is a very high level of commitment." Indeed, some analysts believe that the economic pain caused by low oil prices might be enough to motivate compliance.
But while Saudi sources talk of regaining 1996 and 1997 prices of $18 to $20 per barrel, Luis Tellez, Mexico's energy secretary, was less optimistic. Mr. Tellez says a combination of factors, including better oil-production technology, the widespread substitution of natural gas for diesel in the electricity industry, and the opening of new oil fields, will continue to keep a lid on prices. "We don't see a return to the prices seen in 1996 and 1997 in the medium term," he says.
Indeed, some say the newest round of cuts are so large that the agreement could collapse of its own weight. "The greater the expectation," the OPEC official said, "the greater the disappointment."
Opposition in Venezuela
One problem could quickly come from Venezuela. Union leaders representing oil workers were caught off guard by the accord. Just five days ago, Energy Minister Ali Rodriguez told the union that no more cuts would be made.
Carlos Navarro, head of Venezuela's largest labor union, said on Friday that the union was "absolutely opposed" to further cuts because they would "deepen the fiscal deficit and worsen the social situation."
OPEC and its non-OPEC allies have not cut production since last June, in part out of fear that the cuts would give back market share to non-OPEC producers. Instead, leaders in the cartel reduced output modestly and attempted to force some non-OPEC production off the market.
While OPEC countries talked publicly about reducing output, they were quietly preparing for a time when demand for their oil would rise sharply. Saudi Arabia, Kuwait and Iran have all, in varying degrees, invited foreign investment into their energy sectors in order to boost production and export capabilities.
But the producing countries found their immediate need for cash too great, says Mr. Drollas, the economist. The cuts "are short-term fixes born of desperation," he says. "Longer term, OPEC is not solving anything by doing this." |
