Location: London
Author: John Hall
Date: Thursday, December 18, 2008
Understanding this global market is something that many claim to be able to do but few ever seem to succeed in getting it right. In recent years, the world has had to live with volatility in energy prices and with serious consequences for many consuming nations culminating in the current global economic situation. Less than six months ago prices were being forecast to reach $200 by July and yet, within a few months, they had collapsed to the $40 level. By the end of October a bank economist was forecasting that price would rise to $70 by the year end and then continue upwards. Now, only a few weeks later, that same bank is forecasting that prices will fall to $30 in three months and average only $45 next year. Investors are being encouraged to base decision making on such guess work which in turn impacts on consumers who have to take delivery and so, for OPEC, the decision making becomes even more difficult.
OPEC met again today for the 151st. Extraordinary Meeting, held in Oran Algeria, under the presidency of HE Dr. Chakib Khelil, Minister of Energy & Mines of Algeria and Head of its Delegation and announced that OPEC would with effect from 1st. January reduce output by 4.2mbpd. Initially this sounded quite stunning until Dr. Khelil confirmed that within this figure the previous two cuts had been included. So, in effect, OPEC will cut output back further by 2.178mbpd.
OPEC is naturally very concerned at falling oil prices and is desperate to see a return to higher levels and this was the kind of output cut needed to shock the market in to submission and bring speculators back in to the arena. However, in the short term this has not happened and prices have started to fall further which is precisely the scenario that OPEC is seeking to avoid. Therefore, events leading up to this meeting are important and set the scene for the thinking of today.
OPEC met in September and announced cuts of 522,000bpd, simply to try and take out the overproduction in the market. At that time, we were advised, no further action would be required until the meeting today already scheduled for 17th. December. However, as prices continued to fall, an interim meeting was called for November but that meeting was then brought forward to 24th. October, which became the 150th. Meeting. At that point OPEC announced a further cut in output of 1.5mbpd effective from 1st. November.
The September cut was to have taken effect within forty days and so would not have been felt until mid-October while the impact of the October cut would not have been known until early in December. Yet, a short time later, with Organisation of Arab Petroleum Countries, (OAPEC) set to meet on 29th. November, the non Arab members lead by Iran and Venezuela used the occasion to convene all OPEC members too.
At this point OPEC could not have known the impact of the September and October cuts and therefore was not in a position to determine whether the earlier strategy was working or not. Furthermore, as this date was set around an OAPEC meeting it would perhaps not have been sensible, politically at least, to have used this opportunity to announce a change inn OPEC strategy. Therefore the occasion was used as an opportunity to discuss the market situation and to review and make any decision the next meeting the 151st. on 17th. December in Oran.
OPEC believed early on that the price would continue to fall and that further action would be required to halt the downward trend but, at the same time, it needed to demonstrate compliance to the earlier cuts, something that it has always struggled to manage. OPEC’s view is that compliance to date is around 85% which leaves it with around 300,000 bpd outstanding. However, independent reports indicate that compliance is probably only around two thirds of the total, indicating that the non-compliance element is around 750,000 bpd which is far to much for OPEC to gain credibility and if this level is to be repeated against the new cuts then the noncompliance level could rise to 1.5mbpd.
Dr. Khelil again used the expression that OPEC was keen on “maintaining crude oil prices at fair and equitable levels for the benefit of the world economy and the wellbeing of the market”. He also gave reference to the plight of developing nations together with concern over the prolonged threat of recession which OPEC did not see as easing over the winter period. He also strongly referred to the fact that OECD stock levels were above the five years average at around 57 days when ideally, from OPEC’s viewpoint, they should only stand at 52 days and this overhang as such has given OPEC some of the justification that it needs to reduce output by so much. It is also fearful of demand destruction and with costs having escalated rapidly in recent years in terms of development costs, it feels that the lower oil price is of no benefit to anyone if investment in development for the future is also cut back. Therefore taking all in to account, OPEC will cut output back by a further 2.178mbpd with effect from 1st. January 2009. That means that the target output level from September 2008 for the OPEC 12 will be cut from 29.045mbpd to 24.845mbpd. Sounds very dramatic but reality it probably isn’t when taking the drop off in demand for 2009 and the higher stock levels.
In the lead up to this meeting prices fluctuated and at times, in anticipation of a severe OPEC cut the price rose yet immediately before the meeting the OPEC basket price fell on Tuesday to $40.74 from $42.53 on Monday. OPEC needed to send a shock to the market which in my view was at least 2mbpd up to 2.5mbpd.
As ministers arrived each gave out the message that OPEC members were united in their view that a cut was necessary and anything from 1mbpd was quoted yet when Ali Naimi the Saudi Arabian minister arrived and simply quoted “2m”, the market was assured that this was the kind of level that would materialise.
Immediately before the press conference the overall figure of 2.6mbpd was being mooted and that was understood to have included support from Russia and Azerbaijan. However, when I asked one of the member country representatives about support from Russia I was given a very “dismissive” reply and I gathered that this covered both an official cut from Russia and perhaps too Russia’s overall interest in OPEC. Russia had a very heavy presence here today lead by the Deputy Prime Minister and supposedly the heads of five oil companies and a team of journalists, not seen before at OPEC.
Surprisingly, at the Press Conference, there was no reference to any non-OPEC producer and when Dr. Khelil was asked about support from non-OPEC producers he replied by saying that OPEC would like them to act as OPEC has done, and, presumably, reduce their output by 4.2mbpd too. Somehow, I don’t think that this will happen. There was some consensus after the meeting was that Russian output is in decline anyway, through lack of investment and that supply issues in Azerbaijan have curtailed output from there so, overall, any cutback from these two countries was happening anyway and outside their control.
Nevertheless the sentiment may well have been welcomed by OPEC but something more positive is needed.
OPEC needed to shock the market today and in theory anything over 2mbpd should have been adequate.
Unfortunately for OPEC it has a history of non-compliance and with the view that only around 65-70% compliance can be claimed so far on the cuts announced in September and October it is unlikely that the market will initially treat this additional cut any less seriously. The announcement as it came of 4.2 mbpd sounded worse than it was and it was not until Dr. Khelil added that this figure included the earlier cuts that there was some relief.
OPEC has done its utmost to control prices by manipulating output and I suggested to Dr. Khelil that the time was now right for OPEC to return to the price band and give the market an indication as to the price level that OPEC wanted. He had said earlier that then price needed to be equitable and fair to both consumers and producers but was not able to say what it should be. I also mentioned to him that this would be useful to encompass the demands of different members in terms of their aspirations and needs. Venezuela probably needs a price close to $100 pb but for next year has set a figure of $60 in its budget. This will increase the budget deficit but it is the figure that Venezuela is hoping for.
I also mentioned to Dr. Khelil that during his presidency oil prices had risen from below $100 to close on $150 and now back to below $40 and that he had done well to give out the united view of the members, which one can safely accept was not always evident. Furthermore, in view of these massive price ranges, perhaps now was the time to bring back the price band? In response he reiterated that the world had been content to pay above $100 pb and yet it was the intervention of speculators that caused the price spike and then the financial crisis which then lead to the price collapse. At this meeting one year ago, his predecessor was warned that if OPEC did not increase output it would give the incentive to investors to push the price up over $100. OPEC ignored the advice and the price rose! As for the financial crisis, Dr. Khelil has previously put this down to the mismanagement of the US economy, while once again, there is no reference whatsoever to the impact of high oil prices on economic growth or the role that they have played in creating this global recession initially.
This was one of the largest meetings attended in recent years and attracted very serious media attention.
There was perhaps the suggestion that OPEC would take drastic action which it has done, and that non-OPEC producers would give some official support but that has not happened. It is disappointing that OPEC is able to ignore prices when they reach unsustainable levels for consumers but can then justify whatever action it believes is needed to hold up prices when they reverse and fall. Demand destruction is now very much in the vocabulary for OPEC and it will be interesting to see how OPEC moves ahead under the new Presidency of HE Eng Botelho de Vasconcelos of Angola and particularly as Angola is a country from which additional output can be expected and which urgently needs the additional revenue. As I have said, Dr. Khelil has managed OPEC well during his presidency and ably supported by the Secretary General Abdullah El Badri who will now need to work with the new President and ensure that national ambition is encompassed within the spirit of OPEC.
In the hours after this meeting prices have weakened further but, notwithstanding the supply overhang, looking ahead towards q2 and q3 next year OPEC needs to take care that recovery from recession is not curtailed in any way by OPEC aspirations to push prices back up towards the $100 level but if that is not the objective then OPEC needs to clarify the position and state what the reasonable price should. Uncertainty naturally prevails at this time primarily because day by day different data sets are produced. For today, US stocks of crude and imports increased while demand and refinery utilisation fell, again indicating that it is often the latest data that influences market sentiment and that can change day by day. I feel that prices will remain weak and particularly if OPEC is not able to demonstrate compliance to the output cuts. Should that position change then prices will start to rise. We may see prices in the middle of next year back up to the $50-60 range.
The next meeting is scheduled for March but I should be very surprised if an interim meeting is not called for late January or early February. In the meantime, we shall continue to follow the market and report back.
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