OPEC Rolls Over Again

The 156^th Ordinary Meeting of the OPEC Conference Vienna, Austria, 17th. March, 2010

OPEC met today under the new Presidency of HE Germánico Pinto, Minister of Non-Renewable Natural Resources of Ecuador and President of the Conference for the current year. As with all OPEC meetings the market was awash beforehand with statements from all ministers although this time, each had the same point to make – no change! With the price of the OPEC basket being maintained over $75 irrespective of whatever OPEC says, the members are happy, for now.

In 2008 OPEC announced it would cut output by 4.2mbpd and actually managed to achieve around 80% of this figure albeit for a few months. Today compliance is just a little over 50% which does not speak well of OPEC discipline but with the OPEC basket price around the $75 level no one can blame the members for producing and selling as much as they can. OPEC is naturally aware that fundamentals are not driving the market which also serves to confirm that it is not in control of prices but where the members have to be careful is if the price falters and starts to fall back, as they will then need to rapidly cut and not increase output to maintain revenue streams which is their normal solution.

OPEC appears to be working on output levels, as opposed to quota levels, and by leaving output where it is it is in effect just confirming that these levels are correct for now. I had expected quota levels to be adjusted to match output, to give some sense of compliance but this has been done many times before and may send out signals to the market that output has been officially increased. However, to leave the levels as they are, OPEC is not making a definite statement. OPEC is concerned at the massive OECD stock overhang which currently equates to 60 days as opposed to the 52 days that OPEC prefers. This figure will fluctuate during the next two years, and will also act as a very sound cushion to supply and price changes and, unless OPEC reduces output to comply with the quota cuts, it will remain at current levels probably until 2012. So, unless OPEC makes greater effort to rein in the over producers, which it probably won’t do or be able to do, the higher stock overhang will remain and provide genuine support against price volatility and curtail OPEC’s control over the market.

Seasonal demand for OPEC oil will fall during the second quarter by as much as 1mbpd which will allow the stock overhang to replenish itself from winter draw downs. However, all focus is on resurgence from India and China later this year but it should be recognised that both countries are seeking to take more gas in place of traditional oil usage and furthermore, if world gas prices remain depressed with supplies abundant we shall see the consumers switching from one to the other. The US market has moved from being short on natural gas to very long, thanks to the advent of Shale gas and, as a further consequence, the US will not need to utilise the LNG stations built around the Eastern and Southern points of the US for LNG imports. Instead, the LNG will be available to both European and Asian markets and taken possibly in preference to oil.

As before, the emphasis is on global recovery and on OPEC being ready to respond as demand picks up but, at the same time, OPEC is very much aware that should oil prices rise much above current levels, OECD recovery could well falter and with financial tightening in China the global recovery as such is certainly not guaranteed just yet. Yet China remains the single, fastest growing market for oil with demand growth expected to rise 0.5 million b/d to 8.8 million b/d this year while the People’s Republic announced that the economy grew in excess of 10% in the final quarter of last year and now is predicted to grow at 9.0% this year according to the latest projections from the World Bank.

OECD countries are still not out of trouble and could easily fall back if oil prices rise much above $80, while the non-OECD sector not only depends on OECD support it also has to take care not to overheat itself. We can not ignore the fact that with high unemployment levels both within the EU and the US, respective governments are being overstretched with social security issues adding to public debt and will need some years before employment can return to more acceptable levels and relieve them of the financial constraints.

Within the OECD countries much of the manufacturing sector has been relocated to Asia to make the goods that then OECD countries used to make and so any recovery within the OECD from manufacturing will not be able to recover to pre-recessionary levels. Meanwhile, demand for oil products has suffered certainly within the Western EU countries to the extent that it will not recover and return to original levels. As a result, oil companies are understood to be looking to reduce their involvement in the region which will in turn create higher prices certainly for automotive fuels, transferring through to higher transportation costs which will ultimately be passed on to the consumers. Ironically, in the EU, much of the gasoline produced is exported to the US while Diesel fuel is imported from Russia.

Looking ahead to demand, the table below illustrates the EIA view of supply and demand and from this one can see that the market in 2010 will not even catch up with 2007 demand but will pick up in 2011 but with OPEC overproducing by 2mbpd now, and with the stock overhang increasing further, there should not be any supply concerns just yet.

Further information please contact:- John Hall +44 (0)7785 274530 or Damien Cox +44 (0)1403 269430