Why OPEC Isn't to Blame for Current Oil Prices
MENAFN - Middle East North Africa . Financial Network
Arab News - 04/09/2005
Faisal Sanai
What exactly is the right price for oil? For a century, oil producers and consumers have labored to find the answer to this question. Today, this precarious link between producers and consumers has become dangerously skewed. Crude prices are breaching levels that previously only scaremongering cynics had dared predict. Nothing that oil producing countries can or would do seems capable of reining in the runaway prices. With oil hovering above $68, there is again talk of scarcity, greed and chaos. And the Organization of Petroleum Exporting Countries (OPEC) is the usual suspect in a predicament which is beyond its machinations.
In the last six years the price of oil has fluctuated from a low of $9 to a high of $70 per barrel. Cast back to the year 2000 and one remembers the worry of a global recession aided by the $30 price-tag. Gone are the days when the valves on oil pumps could be regulated either ways to determine the price one has to pay at the pumps. The OPEC price band of $22 to $28 still remains in place but has become a function of its own inadequacies. Calls by consuming nations to increase output are being met by even more vociferous reiterations by OPEC of its intent to do so.
Frankly, the ball isn't in OPEC's court. The organization is no longer in any position to influence crude prices that it is credited to control. However, the question that really needs to be asked is whether OPEC really has the capacity to control prices? With power over two-thirds of the world's oil supply, one assumes it should be so. The reality is somewhat different.
As a finite commodity, the only mechanism by which crude prices can drop is to let production outstrip demand. Today, oil rigs in every corner of the world are pumping in overtime mode to meet burgeoning demand. The fear remains that this "overtime" production may not be able to meet demand. Hence, prices become in part, a reflection of this fear factor. Since OPEC's spare capacity is minimal, it must be viewed not as a "political weapon" but more as a "commodity tool" to be used as a buffer against price shocks. Consequently, widespread concurrence on market realities has translated into a sharp drop in calls seeking an OPEC output hike.
On the flip side, the organization hasn't been able to enforce production quotas for member states initiated in 1973. It's now common knowledge that hardly any amongst the eleven existing members has been compliant with their individual allocations. Save for the production cuts of 2000, the only time members adhered to their output ceiling was when production was set to the maximum, where manipulation obviously became meaningless. This is today's reality.
Secondly, the timing of the organization in effecting supply alterations to the market has been woefully off-mark. Errors were made in timing quota changes along with the usual problems in maintaining production discipline amongst members. Such erraticism only helped to serve consumer's interests.
Having said this, it's almost impossible to predict supply and demand at any given time. Asides from the economic factors, oil markets have always been influenced by political forces. Put differently, the price of crude does not simply reflect equilibrium between supply and demand. On the contrary, it's equally determined by political developments in both producing and consuming countries. Despite beliefs that political crises in isolation are insufficient to cause price shocks when capacity cushions exist in other countries, such crises do bring in their "instability premium".
With one-fourth of the proven global reserves, Saudi Arabia is the world's leading oil producer and holder of spare production capacity. Saudi Arabia's strategic relationship with United States, the world's largest net importer, frequently alters the dynamics of oil pricing.
OPEC is frequently castigated for being the great spoiler in that unending party of cheap oil which the Western countries had enjoyed in the past. Cheap oil was the norm and had been received as the right of all industrialized nations to enjoy. The cynical distrust of OPEC dates back to the oil crisis of 1973, but oil consumers have since gradually awakened to the organization's crucial role in maintaining market stability. After crude prices fell to $9 per barrel in 1999, many analysts predicted the end of OPEC. Although it survived the crisis, it did so in a vastly toothless form.
Two things occurred in tandem that has rendered the organization ineffective - accelerating non-OPEC production of the last three decades (and curtailment of OPEC imports by US and Europe) along with the economic growth in Asia and US. The demand for oil has grown to the point of becoming almost insatiable. Moreover, the geopolitics of the Middle-Eastern region continues to exert speculative pressure on prices and is beyond the organization's market control. Last week Saudi minister of oil and mineral resources, Ali Al-Naimi, was bemoaning another variable that the problem lay squarely in world refinery shortages.
Prevailing wisdom suggests that a high crude price is good news for OPEC in today's money but, bad news in the longer term. The inflationary effect of high prices would eventually start knocking on the doors of the producers themselves, thereby offsetting most of the gains. Additionally, soaring prices would spur oil extraction from economically-compromised places like the "tar sands" of Canada or from the deep waters of the Arctic. The concern over this boomerang effect speaks volumes of the organization's desire to ensure market stability.
High crude prices have so far not slowed economic growth noticeably, and they're only beginning to affect oil demand at the fringes. Current estimates suggest that the excess production from newly developed sites would quite easily be absorbed to maintain the rising demand of oil in the near future. Also, advances in oil exploration and production technologies seem insufficient to offset declining resources. Furthermore, analysts estimate that the world is nowhere near switching over to alternate sources of energy that oil-producing countries seem to live in mortal fear of.
The correct price for oil would logically be the one that consumers are still willing to pay. So, is last week's over $70 the right price for the market? Perhaps not. This time around the party may be in the oil producers' camp but, like all parties, it will come to an end; and sooner rather than later. The only thing that OPEC can do until then is to sit pretty, and enjoy the show.
(Dr. Faisal Sanai, faisalsanai@hotmail.com, is a Saudi physician working at the Armed Forces Hospital in Riyadh.)
Arab News - 04/09/2005
Faisal Sanai
What exactly is the right price for oil? For a century, oil producers and consumers have labored to find the answer to this question. Today, this precarious link between producers and consumers has become dangerously skewed. Crude prices are breaching levels that previously only scaremongering cynics had dared predict. Nothing that oil producing countries can or would do seems capable of reining in the runaway prices. With oil hovering above $68, there is again talk of scarcity, greed and chaos. And the Organization of Petroleum Exporting Countries (OPEC) is the usual suspect in a predicament which is beyond its machinations.
In the last six years the price of oil has fluctuated from a low of $9 to a high of $70 per barrel. Cast back to the year 2000 and one remembers the worry of a global recession aided by the $30 price-tag. Gone are the days when the valves on oil pumps could be regulated either ways to determine the price one has to pay at the pumps. The OPEC price band of $22 to $28 still remains in place but has become a function of its own inadequacies. Calls by consuming nations to increase output are being met by even more vociferous reiterations by OPEC of its intent to do so.
Frankly, the ball isn't in OPEC's court. The organization is no longer in any position to influence crude prices that it is credited to control. However, the question that really needs to be asked is whether OPEC really has the capacity to control prices? With power over two-thirds of the world's oil supply, one assumes it should be so. The reality is somewhat different.
As a finite commodity, the only mechanism by which crude prices can drop is to let production outstrip demand. Today, oil rigs in every corner of the world are pumping in overtime mode to meet burgeoning demand. The fear remains that this "overtime" production may not be able to meet demand. Hence, prices become in part, a reflection of this fear factor. Since OPEC's spare capacity is minimal, it must be viewed not as a "political weapon" but more as a "commodity tool" to be used as a buffer against price shocks. Consequently, widespread concurrence on market realities has translated into a sharp drop in calls seeking an OPEC output hike.
On the flip side, the organization hasn't been able to enforce production quotas for member states initiated in 1973. It's now common knowledge that hardly any amongst the eleven existing members has been compliant with their individual allocations. Save for the production cuts of 2000, the only time members adhered to their output ceiling was when production was set to the maximum, where manipulation obviously became meaningless. This is today's reality.
Secondly, the timing of the organization in effecting supply alterations to the market has been woefully off-mark. Errors were made in timing quota changes along with the usual problems in maintaining production discipline amongst members. Such erraticism only helped to serve consumer's interests.
Having said this, it's almost impossible to predict supply and demand at any given time. Asides from the economic factors, oil markets have always been influenced by political forces. Put differently, the price of crude does not simply reflect equilibrium between supply and demand. On the contrary, it's equally determined by political developments in both producing and consuming countries. Despite beliefs that political crises in isolation are insufficient to cause price shocks when capacity cushions exist in other countries, such crises do bring in their "instability premium".
With one-fourth of the proven global reserves, Saudi Arabia is the world's leading oil producer and holder of spare production capacity. Saudi Arabia's strategic relationship with United States, the world's largest net importer, frequently alters the dynamics of oil pricing.
OPEC is frequently castigated for being the great spoiler in that unending party of cheap oil which the Western countries had enjoyed in the past. Cheap oil was the norm and had been received as the right of all industrialized nations to enjoy. The cynical distrust of OPEC dates back to the oil crisis of 1973, but oil consumers have since gradually awakened to the organization's crucial role in maintaining market stability. After crude prices fell to $9 per barrel in 1999, many analysts predicted the end of OPEC. Although it survived the crisis, it did so in a vastly toothless form.
Two things occurred in tandem that has rendered the organization ineffective - accelerating non-OPEC production of the last three decades (and curtailment of OPEC imports by US and Europe) along with the economic growth in Asia and US. The demand for oil has grown to the point of becoming almost insatiable. Moreover, the geopolitics of the Middle-Eastern region continues to exert speculative pressure on prices and is beyond the organization's market control. Last week Saudi minister of oil and mineral resources, Ali Al-Naimi, was bemoaning another variable that the problem lay squarely in world refinery shortages.
Prevailing wisdom suggests that a high crude price is good news for OPEC in today's money but, bad news in the longer term. The inflationary effect of high prices would eventually start knocking on the doors of the producers themselves, thereby offsetting most of the gains. Additionally, soaring prices would spur oil extraction from economically-compromised places like the "tar sands" of Canada or from the deep waters of the Arctic. The concern over this boomerang effect speaks volumes of the organization's desire to ensure market stability.
High crude prices have so far not slowed economic growth noticeably, and they're only beginning to affect oil demand at the fringes. Current estimates suggest that the excess production from newly developed sites would quite easily be absorbed to maintain the rising demand of oil in the near future. Also, advances in oil exploration and production technologies seem insufficient to offset declining resources. Furthermore, analysts estimate that the world is nowhere near switching over to alternate sources of energy that oil-producing countries seem to live in mortal fear of.
The correct price for oil would logically be the one that consumers are still willing to pay. So, is last week's over $70 the right price for the market? Perhaps not. This time around the party may be in the oil producers' camp but, like all parties, it will come to an end; and sooner rather than later. The only thing that OPEC can do until then is to sit pretty, and enjoy the show.
(Dr. Faisal Sanai, faisalsanai@hotmail.com, is a Saudi physician working at the Armed Forces Hospital in Riyadh.)
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