Tuesday, March 23, 2004

OPEC Waffles
Last month OPEC ministers decided to reduce oil production in the second quarter, even though the market is currently at historic highs. Their rationale centered on avoiding a glut in the in the upcoming post-winter heating, pre-summer driving season. Dissent now seems to be dividing the ranks before the cuts go into effect, as unnamed members wake up to the political damage that sustained high prices is causing them, and more importantly, to the risk that their actions will slow the economic recovery and reduce demand for the next couple of years.

It's about time. Over the last decade the market has swung back and forth between periods when OPEC could control prices and others in which a lack of OPEC cohesion or tranches of new non-OPEC production left them powerless to prevent a price slide. But as time passes, this game becomes riskier. Alternatives are creating new choices for industry and consumers, and each successive price spike takes a small notch out of future oil demand. These alternatives include not only wind and solar power, but more conventional fuels such as LNG.

As always, OPEC's leaders must find a way to balance the desires of members such as Algeria and Indonesia, whose limited production and reserves drives them to maximize short term revenue, with those such as the Saudis and Kuwaitis, whose reserves will last decades and who must lose sleep over the prospect of losing the market to coal, gas or renewables. But neither can they forget 1998, when the slide in prices due to falling Asian demand became a collapse. Let us hope they realize that this kind of scenario is highly unlikely today, as China booms and the US gets back on a growth track.

The FT quoted the Algerian representative fretting about a possible $7 drop in prices. $30 oil would take about 17 cents out of the gasoline price, and that would be good news indeed for consumers.

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