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Editorial / Commentary / Opinion



John Hall: OPEC monitors economic
activity and rolls over output targets !

The 154th. Ordinary Meeting of the OPEC Conference
Vienna, Austria, 9-10th. September, 2009

This morning the OPEC President HE Eng Botelho de Vasconcelos of Angola, supported by Mr. Mr. Abdalla Salem El- Badri the Secretary General, presided over the OPEC Conference. The general consensus beforehand was that
nothing new would come out of this meeting yet there is always that sense that OPEC could spring a surprise. However, this was actually an official meeting of the OPEC conference and one that was required to enable members to discuss and confirm ongoing strategy. Furthermore, OPEC needs to be seen to be
monitoring market indicators but as Ramadan was being observed the meeting was held through the night which no doubt curtailed some enthusiasm for a lengthy debate. What will follow this meeting will be governed very much by economic activity and whether OPEC members can report a genuine increase in demand for their products, but with OECD stocks at record high levels it could take well into 2011 for them to be depleted back to 52 days. So, for now,
consumers probably have some level of advantage, but, for how long?

We have analysed the forecast production and consumption data for OPEC and the impact on OECD stock levels which currently stand at around 62 days forward cover as opposed to the OPEC preferred level of 52 days. If OPEC had not imposed the cuts of 4.2mbpd in 2008 those same stock levels today could have risen by now to around 80 days but for OPEC to leave output levels where they currently are the, stock levels will rise further to around 66 days by the end of 2010. However, to reduce the levels back down towards the 55
days level, OPEC will need to ensure full compliance of the cuts and reduce output by a further 1,000,000 bpd and even then full compliance will have to be maintained throughout. This is something that OPEC will be Furthermore, consumption levels pre-recession are unlikely to be matched within the
same period and so full recovery is some way off. Nevertheless, as the stock overhang has transferred from crude to product, OPEC has the view that this can be quickly depleted as demand builds up in Q4 and even eliminated in Q1 2010. Based on our figures we have some difficulty in accepting this.

At the last meeting, OPEC announced there was no need to adjust quota levels as compliance was good, at 80%, which allowed an over production of a mere 840,000 bpd. It also stated that demand would soon pick up as the recession was ending and recovery well on its way. As one ministers told me, it would all be over by the end of the year. At that point, I felt that the price of oil would range between $55 and $65 for Brent Crude with the higher level towards the end of the year. However, within minutes of that meeting ending, the market
perceived that supply would soon be under pressure and the price moved up. Since then, it has touched $75 but as we moved towards this meeting it has fluctuated supported by a further weakening of the US dollar while output compliance has now slipped to below 70% to increase the stock overhang further.

Fundamentals are no longer a true reality and OPEC is both aware and concerned about this. Unless OPEC has any hard facts to support its theories or it has the ability to implement further actual cuts in output, the price will float depending upon what the best view is. For OPEC to reduce output further it would take decisive action by Saudi Arabia and that is not likely just now. The threat of any such cut now would jeopardise the recovery programme and cause a rift with western countries and particularly the US which is actively involved in seeking Middle East peace. As Mr. El-Badri the OPEC Secretary General said earlier in the year there is a new dialogue with the US which seems very welcome after the Bush years and one that some Middle Eastern countries are willing to give support to. At the same time, there is renewed effort to bring about peace in the Middle East which has to be to the benefit of all in the region although naturally some will not see this.

So, the renewed initiative from the US to revive fractured relationships across the region and to effect a peace deal between Israel and Palestine makes it seem very unlikely that Saudi Arabia would want to jeopardise the
new initiatives and also damage the hopes of recovery particularly amongst Western countries like the US and its allies.

OPEC’s next meeting is scheduled for 22nd. December in Angola and unless the current OPEC President has a robust plan. OPEC has a quota system in place but the Presidency has not recognised this and as a consequence OPEC credibility has suffered. Nevertheless, prices have remained strong for the OPEC
members but the world is still in a weak position and they have been extremely fortunate to have benefitted from prices as high as they have been. I think they recognise this. Between now and then OPEC will have the chance to monitor the market.

Whenever prices rise, output creeps up as producers seek to slip in additional loads at the higher prices and almost as if no else notices! In recent years, there has been much conjecture over whether Russia would join OPEC or not. I have always felt that Russia would not join any organisation which it could not control and particularly one that would make decisions that it would be expected to adhere to. As OPEC has cut and the price has risen, Russia has increased output and surpassed that of Saudi Arabia. So for Saudi to support the OPEC cuts by taking on more of the share for itself and to have fellow OPEC members increase output and increase market share at the expense of Saudi while Russia gains too at the expense of Saudi, one has to ask how long Saudi will tolerate this before it responds with increased output should its customers request it.

There is an added dilemma for Saudi and also for OPEC and between now and the meeting in December it will be interesting to see how Saudi responds. Saudi currently produces slightly over 8mbpd although in 2008 averaged 8.9mbpd against the Russian output of 10mbpd. Saudi has continued investment in its own resources despite lower prices and could now increase to 12.5mbpd if it so wished so could exert some pressure on Russia. Russian output was supposed to have peaked but there are still vast reserves in the country and with the improvement of new technology the more difficult sectors are becoming feasible but Russia has great difficulty in working with external partners such as International Oil Companies.

Furthermore, the Russian psyche is difficult to follow in that the Russian Government, or at least parts of it will act to suit itself. Russia is a threat to OPEC producers and they probably know this and possibly with Western
guidance will at least try to address the issue. Ironically, Russia has always been welcome at OPEC meeting perhaps more as a means of appeasement but looking ahead now I feel that OPEC should issue the ultimatum to Russia – either join and sign up to the rules or leave! Oil prices have remained strong and certainly when taking in to account the continuing effect of recession plus
the vast stocks being held in OECD countries. OPEC can certainly claim that the cuts imposed so far have controlled or balanced the market but with compliance faltering and the stock overhang increasing they are now powerless to act further. For consumers, they can pay higher prices or draw from stocks in they wish. In the background, both crude and distillate stocks are high and certainly with less goods being moved around on land, diesel usage has plummeted while gasoline the US driving season has now officially ended with the news that Labour Day consumption was down by 13% reflecting the lower demand and without the threat of any serious hurricanes so far in the Gulf of Mexico.

The market was encouraged by the recent announcement that the BP led consortium had struck a major find in the Tiber field in the Gulf of Mexico yielding in time another 250,000 barrels of light crude each day will have
had a positive effect on the region. This is one of nine wells that BP is drilling and with the depth of 10.75km having been reached to extract the oil the significance is far reaching – the technology has been proven to reach such depths which means that vast reserves in the Gulf of Mexico and off the South American coast can be exploited and for the US today that means another 250,000 bpd of non-OPEC oil in home waters.

OPEC now needs to concentrate on the global recovery and ensure that it gets its facts right. The announcement last time that the recession was nearly over was premature although without it prices would have remained lower. Yet, the same statement was repeated today. Price stability was achieved and now
that seasonal demand is set to pick up as winter approaches, OPEC will be in a stronger position whether or not it is able to adjust output further. Data is key to understanding the activity and forecasting demand and from the limited data available we can observe that the rate of decline of GDP in the EuroZone has actually fallen and from a figure -2.5% in Q1 of 2009 against the previous quarter to a figure of -0.1% IN Q2 OF 2009 there is some indication of improvement although the data for Q3 will confirm if this is being sustained.

New industrial orders have wavered month on month over the last year or so and whereas they were 8.78% down in December against November by June of this year they were up at 2.73%. However, we don’t really know whether stock depletion has played a role here but in terms of industrial output December 2008 was 2.97% down on November and after an increase of 0.61% in May against April, in June it had fallen by 0.46% against May but the rate of decline month on month was much lower that the figures recorded towards the end
of 2008.

In the US we have a different trend and GDP was seen to be increasing quarter on quarter until Q4 2008 when it fell by 5.4% against Q3. Since then some signs of recovery have been seen and for Q2 2009 the figure was only 1% down on Q1while unemployment has continued to rise and in August reached 9.7%,
double where it was early in 2008, and we don’t know whether or not it has yet peaked. Meanwhile industrial output and orders are both modestly up.

Overall, data quality is an issue and we can only work on what is readily available and taking data from the EU and the US it would seem that recovery is coming through but very slowly and still with much concern in the US and particularly over the unemployment figures which will have a very serious effect on any economy whether recovering or not. In the Eurozone unemployment has reached 9.5% and as unemployment levels are lagged behind other data sets, until we know that it has peaked we have no real confirmation the
recession has truly reached the bottom. OPEC recognises this and with the current price level well over $60 allows it to wait and see what develops.

The fundamental question now is – how far can oil prices go before recovery falters and we slip back? Once we hit $80 the impact on other fuels such as gas is felt and manufacturing certainly in the EU is hit hard but with overall depressed output the demand will remain low and will take some time to reach forecasted consumption figures set before the recession began. I asked Mr. El Badri as to what action OPEC might take as the price rose towards $90-100 and again suggested a price band. However, he emphatically stated that a
price band would not work and that investment in the industry to increase the capacity needed for the future required and that price below $75 was not enough. The price needs to be sustained above $75 and so far this year has only averaged overall about $52. In so far as taking action as prices rose, there was no indication that this would follow, which conflicted with the views of the delegate that I spoke to earlier in the day who implied that OPEC would be concerned at the external pressure that would follow! It’s a sensitive topic and
one that will not get readily answered!

OPEC must develop and pricing policy and assure that it acts when prices exceed a certain level as it does when they fall below what it perceives to be the minimum level, probably around $50. Certainly if it was to fall below this level OPEC would be very concerned but when looking up the scale to higher prices, there will be similar concern as it moves closer to the $100 level and for the first time in some years there are signs that OPEC will strive to control prices within a range which I should like to think will be initially set at $60-80.

One can argue that India and China will increase consumption but as of today their overall requirement is less than 15% of the global market and two thirds of that of the US so as countries like those in the US and EU cut back or do not increase their output relative to India and China, the impact of increased demand from India and China will be diluted.

As China too recovers from the effects of recession it will be noticed that as China seeks to pass on its costs to its customers, namely Western countries they in turn will buy less and stunt China’s perceived growth. Yet China will not be alone and other eastern countries like will seek their share of the new industrialised opportunities as more and more western companies move east.

This in turn will create severe competition and one hopes keep prices of manufactured goods down and far lower than they were when being produced
in the West. A price has to be paid for everything whether it’s in oil and gas or indirectly against the products produced, and if the customer can’t afford it, it won’t be made. It has been a difficult meeting to follow and I do not believe we shall see any decisive action from OPEC until well in to 2010 after the forthcoming winter.

Looking ahead from this meeting we can probably expect price volatility to continue and in the shorter time prices will again fluctuate around the $70 level. OPEC believes that speculators are distorting the market and causing further volatility although it has not yet said what action it will take to suppress this. It acknowledges that various governments have discussed regulatory proposals but nothing has as yet been agreed or implemented. Meanwhile fundamentals are not in real evidence today the perception for five years ahead is one of tightening supply and hence pressure on the price for today. Nevertheless, the curve has dropped by $5 over the last month and for 2017 is only showing a price around $90 and so the market is not unduly concerned right now.

OPEC is also aware that the forthcoming meeting in Copenhagen to discuss climate change negotiations will have an impact on its member countries and wants to ensure that all are properly represented. It must also be concerned that as prices rise oil becomes susceptible to alternative fuels as environmental controls become more prevalent around the world and therefore higher prices may not be as beneficial to producers as it has traditionally believed. Overall, therefore, OPEC has much to contend with in terms of production and
consumption levels, price controls and the impact of environmental regulations and all assuming that recovery is more short term than long term. Such issues will need to be addressed at the December meeting in Angola.



John Hall is a London-based analyst who runs his own oil consultancy, John Hall Associates . Further information please contact: - John Hall +44  (0) 778 527 4530 or Damien Cox  +44 (0) 140 326 9430  +44 (0) 140 326 9430 . Petroleumworld does not necessarily share these views.

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