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John Hall : Analysis: The 148th OPEC conference

Analysis: The 148th. Ordinary Meeting of the OPEC Conference
Vienna, Austria, 5th. March, 2008

The Market is still well supplied

This meeting had the prospects of some excitement knowing that the Ministerial Monitoring Committee (MMC) would provide the Ministers with detailed information enabling them to make their decision on output, which they had been unable to make at the last meeting only one month ago. Open access to ministers was given beforehand but it was learnt at an early stage that even though, technically, OPEC could reduce output, in line with falling seasonal demand from April onwards, politically, no such move would be seriously considered.

The OPEC President, HE Dr Chakib Khelil, Minister of Energy and Mines of Algeria said yesterday that he, as Algeria, believed that OPEC would like to reduce output as Iran and Venezuela had suggested although it was the Iranian Minister who actually stated later on that the MMC would recommend a roll over of last month’s decision and therefore output would remain unchanged. In spite of what individual ministers may say, each of them is enjoying the higher prices and I can not believe that any one minister would like to sanction a cut back in their own domestic output at this time, with the exception of Saudi Arabia which ultimately has the controlling interest. President Bush again called upon OPEC to increase output, which politically it should do, but in this time of intense geo-political tension, it would be difficult for Saudi or any other producer to acquiesce simply because President Bush had asked them to and Dr. Khelil said, when questioned, he had no need to respond to this request. Such a request should be discreet.

It is a complex market set up and for OPEC, the direct controller of 40% of world output, one has to assess whether OPEC is in control or whether circumstances have led it to become simply a price taker, as it declares itself, as opposed to the price maker that it truly is. One should also acknowledge that non-OPEC producers sitting alongside OPEC control a further 20% of the market and so collectively, 60% is in the room. As consumers, we want OPEC to increase output to bring the price down but from the speculative view, with equities falling, commodities have moved to the front line and with investors looking to hedge against volatility elsewhere and inflation, commodities provide the ideal haven for them. But in pumping excessive funds in to the oil market and viewing it purely short term it leads to over pricing, and as I and others have said before, probably by as much as $30. As the price has been driven up it has fuelled inflation and lead to recession. Yet OPEC will argue that as the dollar has fallen against the Euro by as much as 45% in the last four years that the price to OPEC is closer to $70 anyway and high oil prices have had no effect on the dollar’s fall.

OPEC has no option other than to hold output where it is. It can take a chance and hope, once more, that fundementals will come back in and, as demand falls, driven by seasonality and ongoing recession in the US and elsewhere, that stocks will build and price will “stabilise”. However, with the danger of “over supply” and here there will be a difference of opinion between OPEC and others such as the IEA and EIA over this, the responsibilty will no doubt fall ultimately on Saudi Arabia to reduce output, to balance supply and demand. On the speculative view, there is a danger that if the players do not look beyond the next month they will cause a major collapse in the market by pushing it up when fundemenatally it wants to fall back.

Fundamentals are not being considered and much of the forward thinking if there is any, is short term. Geopolitical tension in the Middle East traditionally referred to the Israel-Palestine conflict running long before OPEC was founded. Today, it is not featured and as I was questioned recently when I mentioned it “why, neither country has any oil!” As the oil fields were developed in the Middle East, the expertise and resources came from predominantly western based companies from countries led by the US and those same countries tended to be those that stood behind Israel while those that needed the resources stood alongside Palestine. Hence, a long term standoff that curtailed development of the oil fields in the Middle East. Oil was cheap and often below $20 but today with oil around the $100 mark many of the producing countries have gone as far as they dare to dismiss the International Oil Companies whether in the Middle East, South America or Russia.

The current dispute between Venezuela and Exxon Mobil highlights this issue most clearly and adds not only to the tension as Ecuador calls on OPEC to come to Venezuela’s defence against the US based Exxon Mobil. On another border, Venezuela is threatening its neighbour Colombia over Colombia’s attack on rebel stronghold in Ecuador. It is not actually Venezuela’s fight but, on behalf of Ecuador, President Chavez has taken it up and once more, Venezuela has got itself embroiled in another external conflict which can only weaken its overall position and draw on resources that would be far better utilised in restoring lost oil production bringing output closer to 3mbpd as opposed to 2.5mbpd.

One aspect I never really understood some thirty years ago was why the Middle Eastern producers didn’t look further and go for gas? The general view was that the revenue from oil was such so why bother with gas? Today, with oil reserves set to decline as they are being depleted faster than they can be replaced, all oil producing countries now want to step up the search for gas but the resources and expertise available to them comes predominantly International Oil Companies’ (IOCs) but IOC’s control over the world’s oil reserves has greatly reduced in recent years. So, even though Venezuela is in serious dispute with Exxon Mobil it will need to reach an agreement and work with others such as Conoco Phillips and Chevron to develop the gas fields and those same companies will surely want to ensure that they have enough cover in place not to be ousted again once the investment starts to bring in a return? Shall we see a revival in deals with IOCs across the gas producing nations?

OPEC has always maintained that it does not get itself involved in disputes that individual members may have with other countries or organisations yet here we have President Chavez of Venezuela calling for OPEC support and stories that the OPEC lawyers are working on the case. Meanwhile Dr. Khelil did say beforehand that it would be discussed at the meeting but that did not mean to say that OPEC would respond with support. It can discuss anything it chooses provided that a member tables the question but if OPEC does take it up and disputes the judgement of different courts from around the world, whether in Europe or the US, it will most certainly enter the political area and that will be very difficult to reconcile itself to.

When Dr. Khelil was questioned about support for Venezuela he asked that we refer to the Press Release as below and this is somewhat difficult to follow:- “The Conference expressed its support to the Bolivarian Republic of Venezuela and Petroleos de Venezuela SA (PDVSA), in the exercise of its sovereign rights over its natural resources, in accordance with international law, a right reiterated by the Algiers, Caracas and Riyadh Summit Declarations of OPEC Heads of State and Government. The Conference called for resolving any such disputes through good faith and amicable negotiations, and excluding ex parte pre-judgment measures which will make finding fair solutions more difficult.” I think this means that OPEC would hope that the two parties could reach agreement between themselves and I am sure this will develop further.

OPEC members may naturally want a show of solidarity across its members but different members have very different objectives and for the President and Secretary General a very delicate diplomatic balancing act is called for. If OPEC does take on this role it will enter in to the debate over many issues including US led actions in Iraq and the US-EU sanctions against Iran and many others. So, for now certainly, even though some members may try to push various resolutions through OPEC an internal split could arise within the cartel and therefore, I do not believe that any such issues will generally become part of the OPEC portfolio.

We talk about geo-political tension and the list of issues is extensive. Further sanctions are being discussed against Iran even after the US declared that Iran had halted its nuclear programme. This week the International Atomic Energy Agency, also based in Vienna, produced evidence almost to the contrary but sufficiently to believe that there is or has been such a programme and that Iran still poses a threat. The US continues to accuse Iran of funding insurgency in Iraq yet President Ahmadinejad of Iran has recently visited Iraq and been embraced by the Iraq administration. Iran is close to Venezuela and Russia too, both countries that can turn against either Europe or the US. At the same time there is ongoing concern about Iran supporting insurgency not just in Iraq but in the Middle East in general and whereas respective oil ministers may be able to work together in some form of harmony, at a higher level tension most certainly does exist.

The problems in Nigeria remain unresolved and from the country’s point of view, around 1mbpd are being lost. Nigeria produces high quality crude, the product that consumers want to buy, but if it came to the market who in OPEC would cut back to allow Nigeria to sell it without flooding the market? Each member is producing at capacity amounting to at least 32mbpd, with surplus capacity determined at around 2.5mb, all from Saudi.

High oil prices do impact on economic growth. Sections of manufacturing have already left OECD countries within Europe and the US and migrated East to countries such as India and China, where energy costs are still as high but they are not coupled with high labour costs and labour and environmental controls. One can argue that such issues are not of great importance but if they do not exist then companies operating in such an environment will have a major advantage over those that do not. The timing may not be finite but for now, there are market opportunities awaiting those that want to take them. From OPEC’s view, overall demand is little changed it’s just that a segment of demand has switched from one place to another.

High oil prices also impact on inflation and contribute to recession and put pressure on the currencies of those contries affected. Oil is still priced in dollar terms and we should not be surprised that the US the largest consuming nation in the world is the one to suffer the most. On tracking oil prices ince 2003 it is not difficult to see how the dollar has lost ground as the oil price rose but now, for those countries that can buy in another currency, the impact of the higher prices is reduced. The dollar has fallen against the Euro by around 45% although less against Sterling. The Euro is very much becoming a universal currency accepted in many Middle Eastern countries too. When questioned over the dollar as the quoted currency for oil, Dr. Khelil reiterated that the oil price will continue to be quoted in dollars but that sellers could sell in whatever currency they agreed upon with their buyers, as it probably has been for some time. Therefore, we can not expect to see oil quoted in any other currency just yet.

Economic growth is also measured by data from the US Institute of Supply Management. This shows that activity in January was down from 50.7% to 48.3% while in the UK, the Chartered Institute of Purchasing and Supply has again stated that inflation including high energy prices is still having an adverse affect on manufacturing as input prices rose from 69.7 to 72.2, the highest since November 2004, coinciding with the rise in oil prices over the same period.

From a positive view, US stocks of gasoline are building up in advance of the driving season to the extent that last month stocks were actually being exported from the US to Mexico, where there were shortages due to lack of refinery capacity and demand for gasoline so imports are required. Gasoline was also sent to Nigeria from where they would move to the European market for commercial gain. In the US there appeared no need to hold the stocks for the US market in advance of the driving season even with the knowledge that demand for gasoline is probably one of the last sectors to suffer in recession. Mexico is producing around 3.1mbpd and exporting half of that with the bulk going to the US but its reserves are being depleted and new finds are in deep water 1,500 to 3,000 metres down so extraction will be difficult but justified by high oil prices.

OPEC believes that fundementals are being ignored and as far as OPEC is concerned the speculators are driving the market up. If OPEC gives the opportunity to investors, they will embrace. They do not need to look long term as they can move from one market to another and until OPEC states that it is concerned about high oil prices and recognizes that it is having an adverse affect on development across the world, the high price and volatility will prevail.

If OPEC sticks to current production levels I feel that prices will weaken but if there is a concerted thrust in to the market and investors over reach themselves and then pull out when fundementals take effect, prices will crash and we could even see them fall closer to the $70 level later this year. With so many uncertainties, I asked Dr. Khelil how OPEC would monitor the market. He outlined the various aspects that OPEC was concerned about and made the point that he and the Secretary General could call a meeting of members at any time, and, if they chose to, could instigate a change in output levels presumably having consulted with members by telephone. Even though the next official meeting is not until September, OPEC ministers will be meeting again next month at the International Energy Forum in Rome and will no doubt continue the dialogue and then perhaps the issue of OPEC output will be determined but at some point they will want to announce a cut in output to defend price, at the same time as maintaining it is a price taker not maker.

It was a very difficult session for OPEC and the outcome was probably the most sensible that we could have hoped for and the fact that the next official meeting will not be held until September is particularly encouraging. OPEC is concerned and is looking for a solution to higher oil prices but without admitting any responsibility. Meanwhile, whilst output is held at around 32mbpd, the price of oil will hold in the $90-100 range in the short term, until conditions change, either an upset in the market or a change in direction from OPEC. Prior to the meeting, on expectation that OPEC would hold output, the price fell $2 and then a short time afterwards when the news came through that US stocks had fallen 3mb, unexpectedly, instead of rising, the price rose again! It is truly an unpredictable market and what I am confident about is that we short term, any true respite for the consumer is still out of reach. I shall join OPEC at the IEF and report back.

John Hall is a London-based analyst who runs his own oil consultancy, John Hall Associates. Petroleumworld does not necessarily share these views.

Editor's Note: Further information please contact:- John Hall +44 (0)7785 274530 or Damien Cox +44 (0)1403 269430.

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Petroleumworld News 03/06/08

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