OPEC’s liquidity trap
Sep 17th 2004
Sep 17th 2004
From The Economist Global Agenda
At its meeting in Vienna, OPEC, the oil-exporters’ cartel, has raised its production quotas by 1m barrels per day. But oil will flow no more freely than before
ONLY the words of Alan Greenspan, chairman of the Federal Reserve, attract closer scrutiny than the hints and whispers of oil ministers and officials from the Organisation of the Petroleum Exporting Countries (OPEC). Fed-watchers must wait until September 21st for another interest-rate announcement to pore over. But the OPEC cartel has provided plenty of words in recent days for its followers to hang on.
Last week, the oil minister from the United Arab Emirates said that OPEC was likely to consider raising the formal production quotas it sets for its members, in response to an oil price that has remained stubbornly above $40 per barrel. At the weekend, other OPEC delegates contradicted him, saying a rise in quotas was unlikely and a cut in production was quite possible before next spring. But at its meeting in Vienna on Wednesday September 15th, OPEC announced that it would raise its quotas by 1m barrels per day (bpd), to 27m bpd, with effect from November 1st. It also decided to meet again sooner than scheduled, agreeing to reconvene in Cairo on December 6th.
If OPEC’s signals are even harder to read than Mr Greenspan’s at the moment, it may be because the cartel finds itself in a position the central banker would dread. When Mr Greenspan sets his target for the federal funds rate, he can be sure it will be met. But when OPEC announces an output quota, it can be quite confident the target will be missed—the cartel is currently exceeding its official limit by as much as 2m bpd. Even worse, OPEC’s oil output is now almost as high as it can go. Raising quotas may thus have no discernible effect on production.
Cartels exist to place artificial constraints on supply. But the constraints on today’s oil supply are all too real. OPEC’s members, excluding Iraq, produced 27.5m bpd in August, according to the International Energy Agency (IEA), which advises oil-consuming nations. The most they could sustain with their current capacity is just 27.8m bpd, the IEA says. Only Saudi Arabia is said to have much spare oil ready to pump, but no one knows exactly how much, how quickly it could be brought to market, or indeed how marketable this sulphur-heavy variety of crude would be.
With supplies stretched this tight, any disruption or disturbance can move the oil price: the insurrectionist sabotage of pipelines in Iraq, the court-ordered sabotage of the Yukos oil company in Russia, or the meteorological sabotage wreaked by Hurricane Ivan in the Mexican Gulf. News of another fall in America’s stocks of crude added almost a dollar to the oil price during trading on Wednesday, leaving OPEC rather upstaged.
The organisation’s current willingness to lift quotas counts for less than its hesitance to invest in new wells and fields. The number of wells drilled by cartel members last year fell by 6.5% from the year before, according to an OPEC report. The cartel has thus far rebuffed most offers from the world's big oil companies to tap its underexploited oilfields. In Vienna, the oil companies pressed their suit with renewed urgency, arguing that OPEC members must let them in now if they are to meet the world's much-expanded demand for oil in ten years' time. OPEC ministers were unmoved.
This reluctance is partly explained by fear: members recall the lessons of the early 1980s, when overcapacity in the industry threw the cartel into disarray, and of the Asian financial crisis, when fear of a deep world recession prompted OPEC to pump too much oil. Complacency is also a factor. OPEC’s nationalised oil companies make their exploration and drilling decisions on fiscal, not commercial, principles. As long as their oil revenues are keeping the government’s budget in surplus, they see no need to expand. Opening up to the oil majors might bring extra investment and cash, but, as Ali al-Naimi, the Saudi oil minister, said on Thursday, “At these prices we don't need it.”
The situation should improve this year and next. Two new oilfields in Saudi Arabia will be ready to pump 800,000 bpd by the end of September, according to the kingdom’s oil minister. These new developments were commissioned to replace ageing facilities elsewhere, the retirement of which may now be postponed. Both Kuwait and Algeria will also inflate OPEC’s supply cushion by the end of the year, according to their oil ministers.
But the new fields and wells touted on Wednesday will still fall short of what is needed to restore OPEC’s power over the oil price. By its own calculations, it would now need more than 3m bpd of spare capacity to function as a genuine swing producer, able to hold the price down as well as push it up. Until then, the physical limits on OPEC’s oil production will bite before the cartel’s quotas do.
If supply does not catch up with it, oil demand may falter—high prices tend to have that effect. The world economy is already slowing. China’s demand for oil, 6.5m bpd in the second quarter, is forecast to slip to 6.3m in the third, according to the IEA. America’s petrol consumption, seasonally adjusted, fell by about 200,000 barrels a day between April and July. The soft patch America’s economy is currently suffering is due “in large measure” to the steep rise in energy prices, Mr Greenspan has said. He has also given warning that the future balance between supply and demand in the oil market will remain “precarious”. OPEC-watchers, tired of poring over the cartel’s empty pronouncements, should perhaps mark the Fed chairman’s words instead.
Last week, the oil minister from the United Arab Emirates said that OPEC was likely to consider raising the formal production quotas it sets for its members, in response to an oil price that has remained stubbornly above $40 per barrel. At the weekend, other OPEC delegates contradicted him, saying a rise in quotas was unlikely and a cut in production was quite possible before next spring. But at its meeting in Vienna on Wednesday September 15th, OPEC announced that it would raise its quotas by 1m barrels per day (bpd), to 27m bpd, with effect from November 1st. It also decided to meet again sooner than scheduled, agreeing to reconvene in Cairo on December 6th.
If OPEC’s signals are even harder to read than Mr Greenspan’s at the moment, it may be because the cartel finds itself in a position the central banker would dread. When Mr Greenspan sets his target for the federal funds rate, he can be sure it will be met. But when OPEC announces an output quota, it can be quite confident the target will be missed—the cartel is currently exceeding its official limit by as much as 2m bpd. Even worse, OPEC’s oil output is now almost as high as it can go. Raising quotas may thus have no discernible effect on production.
Cartels exist to place artificial constraints on supply. But the constraints on today’s oil supply are all too real. OPEC’s members, excluding Iraq, produced 27.5m bpd in August, according to the International Energy Agency (IEA), which advises oil-consuming nations. The most they could sustain with their current capacity is just 27.8m bpd, the IEA says. Only Saudi Arabia is said to have much spare oil ready to pump, but no one knows exactly how much, how quickly it could be brought to market, or indeed how marketable this sulphur-heavy variety of crude would be.
With supplies stretched this tight, any disruption or disturbance can move the oil price: the insurrectionist sabotage of pipelines in Iraq, the court-ordered sabotage of the Yukos oil company in Russia, or the meteorological sabotage wreaked by Hurricane Ivan in the Mexican Gulf. News of another fall in America’s stocks of crude added almost a dollar to the oil price during trading on Wednesday, leaving OPEC rather upstaged.
The organisation’s current willingness to lift quotas counts for less than its hesitance to invest in new wells and fields. The number of wells drilled by cartel members last year fell by 6.5% from the year before, according to an OPEC report. The cartel has thus far rebuffed most offers from the world's big oil companies to tap its underexploited oilfields. In Vienna, the oil companies pressed their suit with renewed urgency, arguing that OPEC members must let them in now if they are to meet the world's much-expanded demand for oil in ten years' time. OPEC ministers were unmoved.
This reluctance is partly explained by fear: members recall the lessons of the early 1980s, when overcapacity in the industry threw the cartel into disarray, and of the Asian financial crisis, when fear of a deep world recession prompted OPEC to pump too much oil. Complacency is also a factor. OPEC’s nationalised oil companies make their exploration and drilling decisions on fiscal, not commercial, principles. As long as their oil revenues are keeping the government’s budget in surplus, they see no need to expand. Opening up to the oil majors might bring extra investment and cash, but, as Ali al-Naimi, the Saudi oil minister, said on Thursday, “At these prices we don't need it.”
The situation should improve this year and next. Two new oilfields in Saudi Arabia will be ready to pump 800,000 bpd by the end of September, according to the kingdom’s oil minister. These new developments were commissioned to replace ageing facilities elsewhere, the retirement of which may now be postponed. Both Kuwait and Algeria will also inflate OPEC’s supply cushion by the end of the year, according to their oil ministers.
But the new fields and wells touted on Wednesday will still fall short of what is needed to restore OPEC’s power over the oil price. By its own calculations, it would now need more than 3m bpd of spare capacity to function as a genuine swing producer, able to hold the price down as well as push it up. Until then, the physical limits on OPEC’s oil production will bite before the cartel’s quotas do.
If supply does not catch up with it, oil demand may falter—high prices tend to have that effect. The world economy is already slowing. China’s demand for oil, 6.5m bpd in the second quarter, is forecast to slip to 6.3m in the third, according to the IEA. America’s petrol consumption, seasonally adjusted, fell by about 200,000 barrels a day between April and July. The soft patch America’s economy is currently suffering is due “in large measure” to the steep rise in energy prices, Mr Greenspan has said. He has also given warning that the future balance between supply and demand in the oil market will remain “precarious”. OPEC-watchers, tired of poring over the cartel’s empty pronouncements, should perhaps mark the Fed chairman’s words instead.
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