OPEC limited in ability to stabilize oil markets

What if the Organization of Petroleum Exporting Countries boosted oil production quotas for the second time in as many months, and the market just shrugged?

That is likely to be the case when OPEC ministers meet July 21 in Vienna. The second stage of a two-phase quota increase is scheduled to be implemented effective Aug. 1.

Quota hike likely

Despite some mixed signals from OPEC ministers in recent weeks, the likelihood is that the 500,000 b/d quota increase will proceed on schedule. It would be the second of two hikes that ultimately would add up to a total of 2.5 million b/d; the first kicked in on July 1.

Concerns over rising inventories and slipping oil prices had prompted the 10 members of OPEC bound by quotas—which excludes Iraq—to take such a cautious, phased approach to bolstering global crude supplies at a time when prices had topped $40/bbl and possible severe supply outages loomed everywhere. That concern had lingered to the point where some OPEC ministers were suggesting the second quota hike might not be implemented after all. At the same time, the group continued to reaffirm its adherence to the largely irrelevant target price band of $22-28/bbl for an OPEC basket of crudes.

But it didn't take long before new events popped up to spawn fresh fears over oil supply disruptions in the third quarter and for oil prices to flirt with $40/bbl again. The market in recent weeks has endured new civil unrest shutting down output in Nigeria, Iraqi pipeline sabotage, industry-targeted kidnappings in Saudi Arabia, the threatened shutdown of giant Russian producer OAO Yukos, and Venezuela President Hugo Chávez vowing to run for president in the fall even if he loses a recall referendum election next month.

So the green light is back on for the second-stage quota increase. But would a quota increase at this point be any more relevant or likely to move the market downward than a reaffirmation of a price band that was left in the dust months ago?

It would appear that through such mixed signals to the market, OPEC—in particular Saudi Arabia—is trying to steer oil prices to a "soft landing" by jawboning the price down when supply threats loom and talking it up when inventories start to bulge. It must be cause for concern for the group to witness such volatility in oil markets today. But in fact there is ample reason for that volatility.

OPEC already is producing above its quota—but just a little less than 3% above. Spare production capacity now is a sliver, a volume easily overwhelmed by a total outage in any one of several troubled crude exporters.

Inventories are indeed growing—in 4 of the previous 5 weeks as of presstime. But instead of being a bearish sign, that could, in fact, point to an added, altogether fresh increment of demand as refiners rebuild stocks not just to average levels but to new, higher levels that reflect growing fears over one or several supply disruptions (more about this subject in next week's column).

Silly season

Which is what makes the latest boondoggle in the US Congress targeting the global oil industry an especially painful reminder that, with an election year, we are in the silly season.

A group of Democratic lawmakers plan to introduce legislation that would force US President George W. Bush to press a complaint with the World Trade Organization that OPEC is an illegal cartel, colluding on production restraint to keep prices artificially inflated, and thus must be broken up. The complaint would target Kuwait, Nigeria, Qatar, Venezuela, and the UAE, all WTO members.

"Even using the May numbers, Indonesia, Kuwait, Nigeria, and Venezuela could not be part of an collusion. A country can hardly be accused of participating in restricting production if it is producing at maximum capacity," noted Ohio energy economist James Williams. "That leaves Qatar and UAE with about 400,000 b/d of excess capacity, which if added to the market might reduce prices by $2/bbl (5%)."

Or it could be a case of "Be careful what you wish for." Forcing OPEC into a production war when global supply is struggling to keep up with demand might just erase what little spare productive capacity there is in the world. That could just scare market speculators enough to jack that price right back up again.

(Online July 12, 2004; author's e-mail: [email protected])