OPEC jittery over high oil
prices By Peter Kiernan
When the news broke last week that Abu
Musab al-Zarqawi had been killed in a US air
strike in Iraq, oil futures at the New York
Mercantile Exchange dipped more than US$1. The
sensitivity of oil-price fluctuations to news
affecting the politics of oil producers is such
that even an air strike against a terrorist icon
moves the market these days, if only temporarily.
The oil ministers of the Organization of
the Petroleum Exporting Countries (OPEC) keep
insisting that the global oil market is well
supplied. At its last meeting in Venezuela on June
1, the group left output unchanged and cited
concerns about the high level of petroleum
inventories in Organization of Economic
Cooperation and Development (OECD) oil-consuming
nations. But oil prices
are
influenced by more than supply and demand
fundamentals, which currently suggest that there
is no actual shortage of crude oil.
The
International Energy Agency's (IEA's) May Monthly
Oil Market report stated, "The absence of a larger
margin of upstream flexibility is one of the key
drivers of current high prices, in conjunction
with geopolitical risks, buoyant economic growth
and a tightness in available downstream [refining]
available capacity."
Indeed, markets are
jittery about supply disruptions caused by a
number of geopolitical crises in major
oil-producing countries, including delicate
negotiations over Iran's nuclear program,
widespread turmoil in Iraq, separatist violence in
Nigeria, geopolitical uncertainty in Venezuela,
and periodic threats of terrorist attacks against
oil facilities in Saudi Arabia.
Political
instability is no stranger to many oil-producing
regions, but current fears of supply disruption
are exacerbated by OPEC's tight spare capacity and
the robust growth in oil demand, especially in
Asia. Oil prices have been pushed higher by the
fear that major OPEC producers don't have enough
oil "in the bank" to cover for a sudden supply
disruption, particularly as strong oil demand
continues to soak up extra production.
Lack of investment from OPEC states during
the time when oil prices were low (the second half
of the 1980s and most of the 1990s) ultimately
left the group unprepared for the current period
of strong growth in oil demand. OPEC's effective
spare capacity is about 1.7 million barrels per
day (mbpd), according to the IEA, or just 2% of
current global consumption. Historically, OPEC's
spare capacity has been much greater, not just in
raw figures but also as a proportion of world
demand (According to Energy Intelligence, spare
capacity was 6mbpd at the time of the first Gulf
War in 1991.)
The current price
environment presents an upside as well as a
downside for OPEC member states, which have a
market share of about 40% of total global supply.
OPEC and other producers are enjoying bumper
revenues not seen for more than 20 years, yet the
group's ability to influence the market has also
been eroded. If overheated prices correct
downward, there might be little OPEC can initially
do about it.
Today's price environment of
about $70 per barrel is a far cry from the oil
producers' crisis time of 1998, when prices
plummeted to just $11 per barrel because of the
Asian economic meltdown. After that price
collapse, OPEC pledged greater cohesiveness in
influencing prices and subsequently member states
tightened output. A combination of successive
quota cuts and a recovery in oil demand pushed
prices back into the vicinity of a price band set
then by OPEC of between $22 and $28 per barrel.
Now the oil market faces a different set of
dynamics, with $70 oil making the long-discarded
OPEC price band in the $20 range seem like a relic
of a bygone era.
According to the US
Department of Energy, OPEC net oil-export revenue
reached $473 billion in 2005 (a 43% increase from
2004) and is forecast to reach $521.9 billion in
2006. In addition to the easing of budgetary
pressures, some producers are able to use the
high-oil-price environment to their strategic
benefit. Oil sanctions against Iran over its
nuclear activities are highly unlikely; Saudi
Arabia remains indispensable while the
neo-conservative dream of promoting Iraq as a
rival producer lies in tatters; Venezuela is
acting more assertively with international oil
firms; and Russia is flexing its muscles as well.
But despite the obvious advantages of
booming revenue and the ability of some of the
larger oil producers to throw around some
geopolitical weight, OPEC as a whole still has
about as much control over the current oil market
as it did when prices plummeted in 1998 - that is
to say, not much. If market sentiment turns from
focusing on tight spare capacity and strong oil
demand to, for example, the threat of sustained
high oil prices to economic growth, there might be
little OPEC can do to prevent prices from
dropping. This may not look likely for now, but
early this month, a very senior oil-industry
figure, BP chief executive John Lord Browne, added
credibility to industry jitters over a price
collapse by predicting that oil could fall as low
as $25 per barrel within 10 years, in an interview
with the German magazine Der Spiegel.
Meanwhile, in testimony to the US Senate
Foreign Relations Committee last Wednesday, Alan
Greenspan, former chairman of the Federal Reserve
Bank, stated that "recent data indicate we may
finally be experiencing some impact" of high oil
prices on economic performance. Greenspan noted
that an increasing number of hedge funds and
institutional investors have begun "bidding for
oil", attracted by the better returns available in
commodity markets than in equities.
While
bullish market sentiment may swell OPEC coffers,
the group also has little control over it. A
former Algerian oil minister told Energy
Intelligence this year, "Once there is a shared
perception [about changed oil market dynamics] and
the speculators decide to pull out, there will be
nothing OPEC can do." OPEC can cut output if
prices fall too rapidly, but these measures take
time to make an impact. In 1998-99 it took OPEC
three successive cuts in production to reverse the
fall in oil prices. In the long term, OPEC is
also worried by high oil prices causing
oil-consuming nations to seek alternative fuels to
petroleum and to consider tougher measures to curb
oil consumption. This occurred after the 1973-74
oil crisis. Furthermore, there are strident calls
in Washington to reduce US dependence on oil
imports as a national-security priority.
Some OPEC officials have even talked about
"security of demand" to counter the call for
"security of supply" by Western government
officials who are worried by dependence on the
Middle East as the major source of global
petroleum supply. Indeed this may translate into
an unwillingness by OPEC to invest too heavily in
building spare capacity for fear that this would
foster a low-oil-price environment should demand
growth taper off. Yet the IEA recently pointed
out, "While conservation and alternative energies
may have an impact in the longer term, there is
only a limited volumetric impact likely to spring
from government-sponsored action in the next five
to 10 years."
For the time being, OPEC
member states will enjoy the economic and
strategic benefits of the current high price
environment. But despite bubbling oil prices,
there is also a trickle of concern from OPEC about
market sentiment one day changing. A key indicator
of this will be if markets begin perceiving that
high oil prices are making an impact on economic
growth and oil demand. In the meantime, expect oil
markets to continue reacting to such day-to-day
news as the elimination of a terrorist, the
destruction of a pipeline, or even a statement by
an Iranian official.
Peter
Kiernan is a Middle East and energy analyst at
AALC, an international consulting firm in the
Washington, DC, area.
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