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Oil Market Update – OPEC meeting
How eager is OPEC really to lower oil prices?
OPEC will increase quotas by 1-1.5mb/d to reduce prices and meet higher oil demand
OPEC’s unofficial price expected to have increased to USD 85-105/barrel as expensive spending programmes weigh on budgets
Internal cooperation put under pressure – OPEC can lose control of market if cooperation fails
We expect OPEC to increase oil quotas by 1-1.5mbd. This is expected to reduce the strong upward oil price pressure in the short term, but declining spare capacity and increasing oil demand will tighten the market further and push prices higher in the medium term.
New preferred oil price range around USD 85-105/barrel
The oil market outlook has changed markedly since the last time OPEC decided to change its oil output target. Within less than half a year from July to December 2008 oil prices had fallen by more than USD 100/barrel. As OPEC were trailing a sharp demand decline and oil prices were hovering around USD 40/barrel, the cartel decided to cut oil production by 4.2 mb/d. At this time OPEC identified USD 75/barrel as a fair price as this was the cost for the marginal producer (the marginal cost of a new barrel of oil) and envisaged an oil price in the range of USD 70-90 per barrel as soon as the world economy was back in recovery phase.
To try to prevent further uprisings governments in the region have introduced huge spending packages. The fiscal packages range widely from 1% of GDP in oil importing countries such as Egypt and Lebanon to about 22% of GDP in the oil producing and exporting country Saudi Arabia.
To finance the expensive spending programmes the biggest challenge for the region’s oil exporters will be to increase the so-called breakeven price of oil – the price at which their budget is balanced while accommodating greater public spending. This means that the MENA region oil producers now need a substantially higher oil price than they needed to balance their budgets in 2009 when the new output quotas were introduced. According to calculations by PIRA, oil producers such as Saudi Arabia, Venezuela and Nigeria need soil prices around USD 85-90/barrel whilst Iraq, Algeria and Russia need prices in the range USD 90-100/barrel and Iran needs oil prices around USD 115/barrel. The average breakeven price has moved up by around USD 15/barrel within less than two years. In our opinion, this should push up the new preferred unofficial price range to around USD 85-105/barrel.
Increase in quotas removes short term upward pressure on oil prices
But even a substantial increase in OPEC’s production quotas at tomorrow’s meeting will not in our opinion calm the market for very long. The oil producers have quietly been increasing oil production since March 2009 and the rate of compliance to the agreed cuts is around 50%. As the oil producers continue to increase oil production, the OPEC spare capacity buffer will decline if no new capacity comes into production. Investments in new capacity were cut sharply during the financial crisis and the access to invest has been restricted in many countries, thereby increasing the risk of supply constraints in the medium term. Although an increase in oil production quotas will remove some of the upward pressure in oil prices in the short term, supply-side bottlenecks are expected to push up oil prices in the medium term. Sustainable OPEC production capacity has increased by 0.45 mb/d by January 2011, but has now fallen as a result of the turbulence in the MENA region and is now 1.17 mb/d lower than in January 2009.
Saudi Arabia is the vital player in the internal tug of war between pleasing the price hawks, such as Iran and Venezuela, and the proponents of a more gradual price adjustment as the growth prospects of the world economy changes. High oil prices will clearly put pressure on the world economy and with the world economy in a maelstrom, OPEC risks prolonging the period of economic contraction and thereby the demand for oil and oil products.
OPEC only able to control market id cooperation works
This meeting will be very interesting from other perspectives as the cartel will need to discuss the development in Libya and who should represent the country at the meeting in addition to raising tension between Saudi Arabia and Iran. The cartel will only be able to control the market and work as a swing producer if the internal cooperation works. An indication of the internal challenges the cartel will be facing at the meeting next week could been seen from the Gas Exporting Countries’ Forum in Cairo yesterday where the Qatari delegation did not turn up, which was taken as a sign of their displeasure over Libya’s attendance.
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