The emergency nature of OPEC’s rushed meeting this Friday is a clear indicator the cartel will be forced to cut output if it is to defend current price levels. It’s no secret the group wants to keep prices at the $70/80 per barrel level. The question remains though - just how far will they go?
Head of global commodities research at Merrill Lynch, Francisco Blanch, sees a cut of as much as 1m barrels a day. Achieving it though could prove difficult. OPEC members are well-known for ignoring quotas. On top of that it’s all about the perception of spare capacity, and the cartel still plans to add 3m b/d to capacity over the next two years.
According to Blanch, history shows it is difficult to maintain discipline in a falling price environment. If economic activity becomes even more dire he says the cartel might be forced to withdraw up to 2.4m b/d of production in the next 12 months. So just how much does OPEC stand to lose by not acting cohesively?
Stephen Schork of the Schork Report sums it up neatly:
Based on projections from the EIA October 2008 (STEO), members of the Organization of the Petroleum Exporting Countries (OPEC) could earn $1,084 billion of net oil export revenues in 2008, and $1,084 billion in 2009. Through September, OPEC has earned an estimated $821 billion in net oil export earnings in 2008. Last year, OPEC earned $671 billion in net oil export revenues, a 10 percent increase from 2006. Saudi Arabia earned the largest share of these earnings, $194 billion, representing 29 percent of total OPEC revenues. On a per-capita basis, OPEC net oil export earning reached $1,137, a 8 percent increase from 2006.
He goes on…
Furthermore, it is widely understood in media accounts that SemGroup, the large physical crude oil marketing company in Tulsa that went bankrupt last summer, got themselves into trouble by locking in (selling) the NYMEX futures beginning around $70/$80. If Sem (and others) really thought the value of their physical inventory was worth $150, then why would they hedge at $80?
OPEC is aware of this. A year ago $75 oil was considered dear by those on the physical side of the trade. Just because a bunch of traders and investment bankers bid the futures market to a ridiculous valuation last
summer, does not necessarily mean that $75 oil today, with a global economy considerably weaker, is cheap. Hence OPEC’s decision for this Friday’s meeting; after all, trying to defend oil at $75 will be easier than trying to defend it at $50.
That’s certainly an incentive to act together and prove the cartel still matters as a price-setting body. But would the cartel go even further? Of real interest is the recent “Russian” presence at meetings.
Johannes Benigni, managing director, JBC Energy Research Centre says the real surprise may come if Russia joins the cuts. While any talk of coordinated action has been furiously denied by the Russians, most recently Energy Minister Sergei Shmatko, the incentive is clearly there. The price of oil has fallen below Russian budget calculations.
At the very least it looks like Opec is asking them to consider, says Benigni.
Russia has recently put more emphasis on its relationship with Opec when they sent their Vice Premier Sechin to the last meeting in Septemer.
What’s more, Opec secretary-general Abdullah al-Badri is set to meet with Russian top-officials in Moscow today to discuss the current oil market situation.
