The June 3 meeting of the Organization of Petroleum Exporting Countries produced no real surprises.
But the oil market still could be in store for surprises this year—and nasty ones at that.
As widely expected, the group hammered out an accord calling for an increase in production quotas. It didn't deliver exactly what some analysts contend the oil market was looking for. If that is so, the oil market wasn't paying attention to the broader context in which the meeting was held.
While the OPEC meeting yielded a phased production quota increase of 2.5 million b/d—2 million b/d immediate, and the second increment coming in August—some analysts grumbled that the quota increase wouldn't put any new oil on the market because OPEC already has been producing over quota by that much.
In fact, the expectation of just such a superfluous quota agreement largely had been factored into oil price levels ahead of the meeting; those prices already were nudging $40/bbl (next-month New York futures) before the latest terror attacks in Saudi Arabia targeting non-Arab and non-Muslim expatriate oil workers.
So the nearly $4/bbl slide in oil prices that came since the day before the meeting might have more to do with whatever OPEC stalwarts were saying outside of the confines of a ministerial meeting. And their message was clear: OPEC soon will be straining its spare productive capacity to the limit in order to better balance the market and keep oil prices out of the stratosphere. The question is, just what is OPEC's spare productive capacity limit right now?
Spare capacity concerns
OPEC's total productive capacity now is 31.56 million b/d, including Iraq, estimates Centre for Global Energy Studies.
The London think tank puts OPEC production at 28 million b/d last month and pegs OPEC-10 (which excludes Iraq) spare capacity at 2.9 million b/d. But an expected surge in Saudi output this month is likely to slash that spare capacity to 2.2 million b/d. Assuming second quarter global oil demand of 79.2 million b/d, OPEC 10 spare capacity thus is a tiny 2.8% of world demand.
This is largely the result of OPEC's failure to add capacity as it pursued a policy of conceding market share to defend oil prices. "However," notes CGES in a June 7 report, "such a policy was always likely to leave the oil market vulnerable to a sudden surge in demand or an abrupt curtailment of supplies—and in the transition from 2002 to 2003, we had both."
Although CGES didn't bring it up, it should be pointed out that non-OPEC supply growth has fallen short of expectations as well. A number of business, financial, and government decisions have contributed to the outlook for Russia, West Africa, Brazil, the Gulf of Mexico, among others, not meeting expectations for oil output either in terms of volume or of timing. Even in the best of times, megaprojects don't appear fully formed and producing at peak in the blink of an eye.
If the terror attacks on oil workers or oil facilities in Iraq and Saudi Arabia aren't concern enough, there is the potential for more violence and civil disorder affecting oil supplies in Nigeria and Venezuela this summer. Even Brazil's oil workers may strike in the coming weeks, perhaps shutting down that country's industry in July. The good news, one supposes, is that Brazil is not a net oil exporter—yet.
Meantime, the Saudis have about 2 million b/d of remaining spare capacity, and there have been unconfirmed reports of the kingdom planning to push output to more than 9 million b/d this summer, perhaps to a level only 1 million b/d below total capacity. And reportedly the other key producers in OPEC with a little spare capacity will whittle those numbers as well, regardless of quotas.
Scary surprises
So what happens if everyone everywhere is producing at full tilt to meet soaring demand, and a major supply outage occurs? It would be a major surprise if oil prices don't top $50/bbl this year.
But the scariest surprise of all is the world being forced, for legitimate reasons—not merely political appeasement over high gasoline prices—to draw down strategic reserves for an extended time. At what point does rationing become the market driver? And what are its global economic consequences?
This is the point where it's tempting just to let the brain shut down in denial over something too scary to contemplate and just hope for the best.
(Online June 7, 2004; author's e-mail: [email protected])
