Opinion – Opec's moving targets
London, 8 June (Argus) — Opec must agree something. That is the true purpose of its meetings. A display of unity is more important than what is actually agreed. Disagreements undermine credibility and destabilise the oil market, which needs to understand what Opec is trying to achieve. A very public spat over production quotas last year forced Saudi Arabia and its Mideast Gulf allies — Kuwait, the UAE and Qatar — to take action to raise output and prompted the IEA to release strategic stocks to compensate for the loss of Libyan exports. And Opec does not want a repeat performance at its next ministerial meeting in Vienna on 14 June.
Finding suitable grounds for an agreement is not getting any easier. The ingenious fudge in December last year restored the appearance of unity by limiting Opec's collective output “to the current production level of 30mn b/d” — thus side-stepping the intractable problem of individual member country quotas. But the organisation will not want to endorse current output of nearly 32mn b/d when its own estimate of the amount of Opec crude needed to balance the market is still close to 30mn b/d. And any agreement must take account of new concerns over the impact of high oil prices on the health of the global economy.
Opec abandoned any pretence at price management seven years ago. The $22-28/bl target price band mechanism agreed in March 2000 was quietly suspended in early 2005 when prices rose because of growing Chinese demand and non-Opec supply shortfalls. The organisation has avoided official price targets since, using quotas or targets to adjust output where necessary in response to changing market circumstances. Its agreement to cut output by nearly 2.5mn b/d in December 2008, after oil demand collapsed at the start of the Great Recession, was instrumental in halting — and then reversing — the dramatic price fall from over $140/bl in August 2008 to $40/bl by early 2009.
But price management is back on Opec's agenda. Fears that another oil price spike could derail the global economy prompted Saudi Arabia to boost output unilaterally in March and make public its intention to move the Brent price down to around $100/bl. And this was supported by Opec secretary-general Abdullah al-Badri. “We are trying to bring down prices to a level that producers and consumers can live with,” al-Badri said last month. Now Brent is close to $100/bl and Opec must decide what to do next.
Agreeing a price target is probably easier than agreeing an output target. The market is oversupplied — partly to reassure refiners that sanctions against Iran will not lead to crude shortfalls and partly to rebuild depleted stocks after last year's squeeze. But setting a lower production target would send the wrong signal and encourage another strategic stocks release by consumer governments.
Opec can afford to take a more relaxed attitude to prices. Oil is unlikely to fall much below $100/bl for long and could double in real terms over the coming decade, a recent IMF working paper says*. Maintaining even very modest oil production growth will require much higher prices than many forecasters assume, the study says. The price used by oil companies to test the viability of new projects has risen to $75-100/bl, compared with $20/bl before 2004. Higher prices encourage new supply sources, such as tight oil from shale deposits. But these do not pose a serious threat to Opec's longer-term market share or revenues.
Non-Opec supply growth is faltering again this year and the global economy is at risk of a double-dip recession. Opec needs to reassure consumer governments it will play a responsible role in balancing the market. Anything less would weaken its authority internally and externally.
*The future of oil: geology versus technology, May 2012
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