OPEC plans further output cut

Posted in Energy Security , Other | 17-Dec-08 | Author: Jad Mouawad| Source: International Herald Tribune

A general view of the OPEC meeting in Oran, western Algeria, Wednesday Dec. 17, 2008.

The OPEC cartel is preparing to announce its biggest oil production cut ever, as producers struggle to contain a collapse in prices amid a global recession, the Saudi oil minister said Tuesday.

The cut would amount to two million barrels a day, or the equivalent of 2.5 percent of global production. It would be the third cut announced by OPEC in three months, and would come on top of previous pledges to reduce production by a total of two million barrels a day.

In addition, producers outside of the cartel, including Russia, may agree to trim their production by as much as 600,000 barrels a day as OPEC appeals to outsiders to prevent prices from falling any further.

The cartel is locked in a desperate race to catch up with plummeting oil consumption around the world. The sudden economic slowdown has trimmed demand and swelled oil supplies, pushing down prices at record speed.

Members of the Organization of Petroleum Exporting Countries, which account for 40 percent of the world's oil, are formally meeting Wednesday in Algeria, their fourth gathering since September, as pressure keeps mounting on them to act decisively.

But the measure of OPEC's challenge came as oil prices fell on Tuesday despite the comments by Ali al-Naimi, the Saudi minister, as concerns about the economy outweighed the news from Algeria. Oil futures in New York dropped 91 cents to $43.60 a barrel.

Oil prices have fallen by about 70 percent from their July peak. After rising above $145, they plummeted to $40 a barrel this month.

"Supply is somewhat in excess of demand, inventories are also higher than normal," Naimi, who is OPEC's most influential representative, told reporters after arriving in Algeria. "To bring things in balance there will be a cut in production of about two million barrels."

Russia, the world's biggest producer outside of OPEC, has sent a high-level delegation to Algeria and has already indicated it is prepared to reduce its production to help prop prices up. Other non-OPEC producers that have collaborated with OPEC in the past, like Mexico and Norway, have so far ruled out any action.

Several members of the cartel have been pushing for a big cut in production. The representatives of Algeria, Kuwait, Qatar and Libya have all spoken in favor of a big move in recent weeks. Iran and Venezuela, which need higher oil prices to balance their budgets, both have said they would like OPEC to slash production by two million barrels a day beyond the cuts already agreed to.

"We have to make a very strong decision," Rafael Ramírez, the oil minister from Venezuela, said in Algeria. "What's important is that there's consensus to cut and that we have to make a big cut."

One problem for OPEC is that compliance with previous agreements has been spotty. Even as producers agreed to reduce their production by 1.5 million barrels a day at the end of October, for example, not every country has followed through. While estimates vary, analysts believe OPEC producers have taken out from 800,000 barrels to a million barrels a day in November.

Since 1997, OPEC has succeeded in restoring prices about 60 percent of the time, according to UBS. But arguably, it has not faced such a challenging environment since at least the 1980s.

The main problem is that oil consumption has taken a plunge in the major developed economies of the United States, Europe and Japan.

But more worryingly for the oil producers is that China might follow. The International Monetary Fund said on Monday that it might cut its 2009 forecast for China's economic growth in half as evidence mounts that the global downturn may spread to the developing world. The warning came as China said its industrial output grew at the slowest pace since 1999.

China's economy, long used to double-digit growth, could slow to 5 percent next year, down from 9.7 percent in 2008, according to Dominique Strauss-Kahn, the fund's managing director.

This means that the growth of China's oil demand, which had been one of the main fuels of rally in oil prices in the last decade, could come to a virtual standstill. Some analysts are even forecasting a drop in Chinese oil consumption in the fourth quarter as the country's exports plummet.

In such an environment, the best OPEC can hope for is to set the stage for oil prices to rebound once the global economy recovers.

As demand slows, global oil inventories have been piling up in developing countries to the equivalent of 58 days of consumption. That is more than six days above their five-year average, and suggests how far oil demand has contracted.

Saudi Arabia has recently signaled that if inventories fell back to 52 days of demand, prices could rise above $70 a barrel.

Two years ago, when inventories last swelled above such historic levels, OPEC ruthlessly trimmed supplies to wipe out the overhang of commercial oil stocks. The strategy worked, sending prices from $50 a barrel to their high above $145 a barrel.

But at the time, the global economy was firing on all cylinders and demand for oil was growing at a sizzling pace.

Few analysts believe OPEC can repeat that success anytime soon.

"OPEC's best path to higher oil revenues may well lie in helping stimulate the global economy by moderating its price targets during the period of economic weakness, but this will require OPEC to accept present pain for potential future gain," according to a report by the Center for Global Energy Studies, a London consulting group founded by Sheik Ahmed Zaki Yamani, a former Saudi oil minister.

"The alternative," the report concluded, "may well be a downward spiral of output cuts and permanent demand destruction."