Too little, too late
Opec has finally decided to increase output. But instead of prices cooling down, crude oil prices surged to a new all-time high
By Karen Remo-Listana
Posted: 24 September 2007
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The Organisation of Petroleum Exporting Countries (Opec) finally broke its silence last week by announcing that they will increase crude output by 500,000 barrels per day beginning 1 November 2007 .
The decision came after weeks of strong pressure from consumers and energy agencies and amidst the much-talked US subprime crisis.
 Prior to that announcement, most analysts have been forecasting Opec would not opt for an increased output as the 12-nation cartel constantly maintained the market is amply supplied.
The decision was attributed to the ongoing tightness in the US products market that continues to affect the level of product stocks and prices.
Opec said it has observed the recent shift of the forward market into backwardation and its implications on stocks. It also noted that the high-demand winter season necessitates keeping the market adequately supplied.
Describing the agreement as “easy”, Dr Hasan M. Qabazard, director, Research Division, OPEC Secretariat, said they already have the facts.
“We know that the market has gone into backwardation and that promote a stock draw. It was just sitting down looking at the facts and then making up their minds,” he said on the sidelines of the Vienna meeting.
The International Energy Agency, the US Department’s Energy Information Administration and the centre for Global Energy Studies have all expressed concern about the rocketing oil price. This is true even if it would mean nothing more than a psychological gesture.
“It would be symbolic gesture, a token to the market that yes we will support you. In a psychological point of view, that will stabilise the prize and hopefully bring the price down a bit,” John Hall, Managing Director, John Hall Associates Ltd, said.
On a contrary, just over 24 hours after announcing the group would pump 500,000 bpd, oil has surged to a new record of over $80.
 And oil analysts and the International Energy Agency, the industrialised countries’ energy watchdog, instead of welcoming the production hike, said that it was “too little, too late”.
Oil futures prices rose sharply after the US government reported a surprisingly large drop in crude inventories and declines in gasoline supplies and refinery activity.
Crude oil supplies fell by 7.1 million barrels in the week ended September 7, more than twice the 2.7 million-barrel decline, the EIA said last month.
Gasoline inventories fell by 700,000 barrels, slightly more than the expected 500,000 barrel decline.
Refinery utilisation fell by 1.6% to 90.5% of capacity. Analysts had expected a 0.1% point decline. And inventories of distillates, which include heating oil and diesel fuel, grew by 1.8 million barrels, more than the 1.4 million barrel increase analysts had expected.
Crude imports fell by 674,000 barrels a day on average to 9.56 million barrels, while gasoline imports fell an average of 298,000 barrels a day to 1.02 million barrels a day.
The intentions of Opec to prop up the world economy hit by the credit squeeze were thus not realised.
The Centre for Global Energy Studies (CGES) blame Opec for the surge in oil prices, saying Opec has managed to force key consumers to trim their inventories through its persistent policy of production cuts.
“As a result of the organisation’s output cuts - initiated at the start of the past winter - there was no increase in global oil stocks during the second quarter of 2007, when they would normally be expected to increase by around 1 mbpd, and third and fourth quarter of 2007 are likely to witness inventory draws averaging 0.75 mbpd,” CGES, which is owned by former Saudi oil minister Sheikh Ahmed Zaki Al Yamani, said.
The study noted that the last time oil inventories were as low at the start of the Northern Hemisphere winter as they will be this year was in 2004.
One more factor in the market reaction is the type of crude that Opec will be adding to the market. Its oil is sulphur – or high in sulphur – so it needs more refining. Refineries on the other hand, are in short supply.
So the effect of Opec’s decision for US light sweet crude prices – the West Texas Intermediate benchmark, for example, may be limited.
“We have to see that refining capacities in the western hemisphere is quite tight,” Cornelia Meyer, an independent energy expert, said. “So how ever much is pumped, it will need to find a home in the refinery. And if it doesn’t find that home in the refinery, there’s no point in pumping crude that has nowhere to go.”
Another question is the source of the increased output. According to CGES, Saudi Arabia is the only country that can raise its output by a significant amount.
“Saudi seems to have persuaded other members to accept a small increase in output, which they hope will prevent prices from rising while preserving the revenues on which many of them have come to depend,” it added.
Iran , for one, cannot meet its Opec quota, so it always wants production reduction. Even though it manages and exploits an estimated 132.5 billion barrels of oil and 296 trillion cubic metres of gas in proven reserves, it failed to deliver to India , China and Japan due to US pressure.
The instability in other major Opec producers such as Nigeria and Venezuela are still far from being resolved.
To prevent further increases in oil prices, Opec members should cut the price of their heavy crude, CGES said.
“Agreeing to produce more oil is one thing; actually selling it will depend on its quality and relative price,” it said. “Opec has long argued that it has been meeting the demand for its oil from its customers, but demand is a function of price and in the case of oil, demand for a particular grade of oil is a function of its price relative to that of other grades.”
According to the study, the discounts against benchmark crude grades for heavy, sour Middle Eastern crude oil have not been sufficiently wide to make these grades attractive to owners of simple, hydro-skimming refineries.
Despite the big jump, oil is still well below inflation-adjusted highs hit in early 1980. Depending on the adjustment, a $38 barrel of oil in 1980 would be worth $96 to $101 or more today.
Oil's recent advance has been largely due to speculative buying by big investment funds, who are responding to a price structure in which oil contracts for delivery in future months are cheaper than the current front-month contract.
Traders say there are big speculative positions in call options that will pay above $80, and the hedge funds want to force the price up so they can collect.
But even if oil is still comparably lower when inflation is considered, the surge in crude prices had become evident as many countries are suffering from inflation, forcing them to raise interest rates.
The Bank of England has raised interest rates five times in less than a year, while the US Federal Reserve increased rates ten times during 2005 and 2006.
With prices rallying above $80 a barrel, Wall Street banks have raised their price forecast for the rest of 2007 and 2008.
Goldman Sachs modified its price target for WTI for the end of 2007 of $85 a barrel, up from an earlier forecast of $72 a barrel, Financial Times reported. The bank also introduced a price target of $85 a barrel for 2008 with a year-end forecast of $95 a barrel.
Barclays Capital has raised its price forecast for 2007 to $68.8 from $66.3. It also raised its 2008 price forecast from an earlier $73.9 a barrel from $77.
Meanwhile, the time lags involved in moving oil from Saudi Arabia and turning it into the products demanded by final consumers mean that any additional oil sold in November will not reach end-users until next year. |
