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Can OPEC Curb The Oil Roller Coaster?
By Oxford Analytica
The last 12 months have seen a roller coaster oil market. In September 2007 the price of West Texas Intermediate averaged $79.69 per barrel. By July 3 it had reached an all-time record level of $147 per barrel. In the last week, it has plunged to below $100 per barrel. The cuts announced by OPEC on Sept. 9 have created significant uncertainties in terms of the effective size of the production cuts involved and the likely impact on prices.
Price increase. Several factors explain the rise in price to the beginning of July:
--There was a perception in the paper barrel/futures markets that the wet barrel market--where physical barrels of oil are bought and sold--faced serious immediate shortages.
--The weakness of the dollar had created knee-jerk reactions in the paper markets, whereby a fall in the dollar was expected to lead to a rise in oil prices.
--Money managers looking for homes for their portfolio investments, finding government bonds very unattractive and equities a disaster, poured money into commodities on an unprecedented scale.
--There were also growing suspicions that some players in the paper markets were pushing the regulatory envelope to the limit, deliberately trying to manipulate the price upward. Although the evidence for this was inconclusive, the regulatory authorities in the United States began to investigate and talk of tightening regulations.
Price drop. However, following the record price peak in early July, prices began to fall back rapidly. There were several reasons for this; in particular, a sudden realization in the paper markets that there were no immediate shortages of oil. Furthermore, many analysts began to publicize the fact--well-known for some time within the industry--that if there were no change in the market numbers, then there would be a potentially serious over-supply in the market toward the end of the year.
OPEC. In this context, OPEC met in Vienna on Sept. 9. At the meeting, OPEC announced that members should "strictly comply" with their crude production allocations. However, there was considerable confusion as to what this meant.
OPEC President Chakib Khelil suggested this amounted to a cut of 520,000 barrels per day, but Saudi Arabia alone is producing some 700,000 b/d above its formal quota. It seems likely that the Saudis were not prepared to upset other OPEC players and preferred instead to resist U.S. pressure not to cut.
--While it seems clear that OPEC will prevent prices from falling too far, there is still uncertainty over what OPEC's price target actually is. This is in part because various OPEC members have different objectives.
--In particular, the OPEC hawks, such as Iran and Venezuela, want higher prices, not least to upset the United States.
--The decision of OPEC to cut was a surprise and led some to speculate that OPEC had adopted a $100 per barrel floor. However, given its control over the market, the Saudi objectives are the key. A view has been emerging that the Saudis are content with a floor of $80 per barrel and would defend that with rigor. However, their desired ceiling is less clear.
Discipline. The numbers suggest that the call on OPEC in 2009 will be flat, requiring discipline to prevent lower prices. Given that the majority of excess capacity will lie in Saudi Arabia, this should not prove too difficult. Expected additional production from Angola and Ecuador is likely to offset Iran and Venezuela's struggle to maintain exports. This suggests the price path will bounce around the 100-dollar mark, which could provide some relief to struggling U.S. and E.U. economies. However, if any major geopolitical outage were to occur--such as an attack on Iran--the market could see increased volatility.
Oxford Analytica is an independent strategic-consulting firm drawing on a network of more than 1,000 scholar experts at Oxford and other leading universities and research institutions around the world. Petroleumworld does not necessarily share these views.
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Oxford Analytica, on 09/19/2008. Petroleumworld reprint this article in the interest of our readers.
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