Extraordinary Meeting of the OPEC Conference

The dramatic increase in oil prices over the last three years has resulted in a reduction of demand forecasts for oil and has intensified the search for alternative energy sources as a means of reducing dependence on OPEC oil. Gas, Coal and Nuclear will benefit and has OPEC taken this in to account when planning for the longer term because if oil prices remain at these levels, supply and demand of alternative energy sources will increase to the detriment of OPEC. At the same time, non OPEC production is set to increase in 2007 and certainly if further business is available at the cost of OPEC, those producers will not hold back and miss the opportunity to increase market share.

Only two months after the Consultative Meeting held in Doha, OPEC has met again and exercised its authority over the world oil market by announcing a potential further cut back in crude output. At the meeting in Doha it was announced that the market was over supplied and that to balance it, OPEC members would reduce their collective output by 1.2mbpd with effect from 1^st. November. Only one month earlier, OPEC seemed keen to distance itself from the quota system which still stands at 28mbpd. Instead this reduction was intended to be taken from actual output levels for September and not from the official quotas. Nevertheless the result was that the overall total would then equate to a figure in the region of 26.4mbpd depending upon which output figures were actually taken.

On that basis several countries, namely Algeria, Kuwait, Libya and UAE would still be producing more than their original official output levels which appeared somewhat unfair for those that were certainly expected to produce well below their official levels. As usual, Saudi Arabia would make up the largest element at 380,000bpd. However, those countries that were underperforming namely Iran and Venezuela were doing so for technical reasons while Nigeria’s output was reduced due to civil war in the Delta region of the country. Indonesia meanwhile has struggled for some time to meet its target figure and was naturally disappointed to learn that it was supposed to cut its output back even further.

When we compare the output figures for November against those for October it would seem that the reduction has only been in the region of 430,000bpd and against September slightly more at 555,000bpd, a long way short of the 1.2mbpd. Furthermore, what we do not know is how these reductions were to be managed? Would they come from contract or spot customers and would the member simply cut back production or process and store the crude? Furthermore, would priority be given to any particular region such as Asia, Europe or the US? Overall though against the original official quota of 28mbpd, output is down by 950,000bpd but not against the September output level quoted by OPEC at 27.61mbpd.

Since the Consultative Meeting in Doha last month, there has been a continuous stream of statements from individual ministers, when questioned, that the market is out of balance and that further cuts are needed to correct the imbalance.

The market has been talked up and now for OPEC to do nothing would be an embarrassment and so the confirmation has been given that from 1^st. February, 2007, output may well be cut by a further 500,000bpd. OPEC has made a statement without actually committing its members to any action. The threat of a cutback to coincide with the usual highest demand quarter in the year will have the desired impact. Prices closed less than one dollar higher, at just over $62 while the OPEC basket rose modestly from $57 to $57.43. Looking ahead, to compensate for this threat of a further cut in production, consuming nations will no doubt increase their demand to build up stocks in advance and particularly in January, the peak demand month in the year. OPEC has called for responsible action from consumers but has not actually said how they should do this. However, with relatively high stocks the market will not react adversely to any threat whether real or potential. Consumers want security of supply while producers want security of demand and for both high stock levels are essential.

The problem for OPEC is that some of its members and in particular Iran and Venezuela have increased their spending in line with the price of all almost like a one way ratchet. It can go up but has no reverse facility! Furthermore, it seems unlikely that these countries are re-investing in their own production and refinery infrastructure and as each has now campaigned openly against International Oil Companies (IOCs) in favour of utilising their own resources they are no longer able to meet their production targets set by OPEC yet they want the price of oil to remain inflated to cover them.

Nigeria is also unable to meet its full quota due to internal long term unrest. Having asked Dr. Daukoru on a number of occasions when peace can be expected the reply has always been that the situation is in hand will be dealt with shortly and one could have assumed that this was one issue that should have been dealt with well in advance of this conference hosted by Nigeria. Basically, the oil wealth is not being passed down to the people and certainly in the Delta region in the south of the country where much of the production is, rebels are attacking installations and kidnapping oil workers.

This topic then moves neatly on to the addition of Angola as the twelfth member of OPEC with effect from 1^st. January. Angola has vast resources which have only recently started to materialise. Already the country is producing around 1.4mbpd so will fit in well with other members and next year intends to increase this to 2mbpd. At the same time Ecuador and Sudan and planning to join, assuming they can pay the membership fees, which is why Ecuador pulled out some years ago. Angola is another African country with vast undistributed wealth in which most citizens live in extreme poverty while civil war is rife in Sudan where the UN is attempting to install peace keepers but against the will of the Government.

No doubt, both Angola and Sudan feel that OPEC membership will give additional political benefit and protection while for Ecuador, a small producer like Sudan of around 300,000bpd, there has to be an additional motive and with the administration somewhat under the influence of President Chavez of Venezuela we can surely expect some more anti US behaviour from yet another OPEC member. This I do not believe will be welcome by the OPEC membership and it will be interesting to see what transpires.

Consumers have demonstrated responsibility by increasing stock levels although recent figures issued by the US indicate that crude stocks, although high, have been drawn down at a faster rate than in previous years and in this way a further escalation of oil prices closer to $70 has been averted. With the threat of further cut backs by the end of next month, no consuming nation can take the risk and assume that the price will remain high enough for OPEC to defer the cutbacks further so they need to take evasive action now and increase their stock levels without delay. The current forward cover of fifty four days needs to be increased closer to sixty to enable consumers to balance their demand and provide producers with the security that they require.

So, where do we see prices moving to now? There is no current geo-political tension and the weather is mild and stocks are still high. However, any one of those factors can change and with the threat of further cuts in February, pressure on price has to be upwards. I still feel that $70 is excessive and believe that unless there is real adverse strife in the market; price will not exceed $65. Should it do so for much of January, then OPEC will have real difficulty in imposing the additional cut for February. What it has done, for now, is to buy time and hopefully in the meantime will re-consider the position and not jeopardise world economic growth or the plight of the developing nations any further.

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