Thursday, June 09, 2011

Do OPEC Meetings Matter?

Yesterday's meeting of OPEC in Vienna attracted extra attention because of disagreements between Saudi Arabia and Iran that extend well beyond the oil fields. The resulting impasse over increasing production to stem high oil prices and support a weakening global economy produced a much-quoted assessment from the Saudi Oil minister, Ali Naimi, who described it as "one of the worst meetings we ever had in OPEC." Yet while the events in the Middle East were at the forefront for most commentators, the outcome of the meeting seems understandable purely in the context of OPEC's own history and the current fundamentals of the market. I'm not sure why so many people appeared to expect OPEC to boost output in anticipation of demand that might not materialize.

I have followed OPEC meetings for nearly 30 years, though not always as closely as when I was trading oil and its products, the prices of which stood to rise or fall depending on what was decided in Vienna. My interest in this meeting went up significantly when I received a call inviting me to participate in a panel discussion about it on the Voice of Russia radio network yesterday afternoon. An hour or two of research revealed a global oil market that is currently well-supplied, with inventories in most developed countries running at fairly typical levels and inventories in the US actually on the high side of normal for this time of the year. That's pretty much the argument that OPEC's price hawks took into yesterday's session.

However, the Saudis and others arguing for higher quotas were looking ahead to the effects of summer demand, especially in rapidly growing Asia, and the buildup of inventories for the fall and winter heating fuel season. They--along with the IEA--anticipated demand growing faster than supply, particularly when the impact of the curtailments from Libya and Yemen are factored in. Such events are important because of the quality difference between the oil that's been shut in in those countries and the spare capacity elsewhere that's available to make up for it.

OPEC's main problem is that the outlook for the global economy has weakened in the last few weeks, and not just because oil has risen to above $115 per barrel, compared to its average of $80 or so last year. The stakes for them look even higher when you factor in a history that includes boosting production in the late 1990s to meet roaring demand in Asia-Pacific, only to see the Asian Economic Crisis slam demand growth in the region into reverse, sending crude prices tumbling from the $20s to single digits by the end of 1998. The doves within OPEC were focused on keeping prices below the level at which large chunks of demand were destroyed in 2008, while the hawks seemed willing to risk that outcome to avert a future price collapse and preserve the revenue they need to fund their national agendas.

The potential consequences for individual OPEC members are substantial. Consider Algeria, which exports about 1.8 million barrels per day. The difference between the current price and what they realized last year equates to more than $20 billion annually. That might sound small in the context of the current debate over trillion-dollar US deficits, but it's nearly 15% of Algeria's GDP. It's no wonder that smaller producers and others with limited capacity to increase output--and thus revenue--would drag their feet on agreeing to raise quotas for countries with spare capacity.

If it sounds like I'm rationalizing cartel behavior that would be illegal in the US, that's not my intent. It's clear to me that oil prices are significantly higher than they would be, because OPEC has chosen to produce around 2 million barrels per day less than it did in 2008. In part they've had to do that to accommodate higher non-OPEC production--think Brazil and Russia--along with rising biofuel production, without weakening prices. The consequences for US consumers are equally clear: Gasoline prices are still more than $1 per gallon higher than a year ago, and even ignoring the impact on diesel or jet fuel that translates into an additional drain of $100-150 billion per year that can't be spent on other goods and services that would contribute more to the recovery.

OPEC meetings do matter, because as long as OPEC possesses both spare production capacity and the discipline to withhold it from the market, it retains the power to control oil prices. If we want to understand the decision process of this group of countries that is always struggling to reconcile its own often-competing, but still broadly aligned self-interests, our assessment should focus on their issues more than ours, however much we are affected by the outcome. Yesterday we saw the price hawks stymie the efforts of those producers who are worried that if they squeeze consumers too hard, demand will fall back to the lows of 2009, costing them hundreds of billions of dollars per year in revenue. But if demand continues to grow, that was surely not the last word, and this debate must be revisited within a few months.

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