October 22, 2008
VIENNA, Austria -- When oil prices go down, OPEC slashes production and the cost of crude rises, right?
Maybe not this time. With the global economy edging toward recession, the specter of diminishing supply has been blown away by a stunning lack of demand that now has the market in a stranglehold.
Ahead of Friday's emergency meeting of the Organization of Petroleum Exporting Countries, the question is not whether the 13-nation group will cut production, but by how many millions of barrels. Spooked by prices that have slid more than 50 percent from record highs of around $147 in July, OPEC is on the defensive.
Chakib Khelil, Algeria's oil minister and OPEC's current president, speaks of a "significant" reduction from the present daily output of around 29 million barrels, and expectations are that the group could pare up to 2 million barrels from that figure.
Rare cuts of that magnitude have in the past led to significant crude price hikes.
But while prices will likely blip upward at least briefly, there are signs that a significant upward trend may be short-lived with fear growing that the worst is yet to come for the global economy.
As concerns spread that recession is reaching all corners of the globe the world's hunger for crude will diminish.
Three months ago, Khelil's comments would likely have pushed oil prices over $200 per barrel. Not this time.
Oil prices tumbled $4 Wednesday after the U.S. government reported big increases in crude and gasoline supplies, suggesting widespread economic pain is curbing energy use.
Crude investors appear to have factored in the likelihood of large OPEC oil production cutbacks and are instead looking to stock markets for signs on how the U.S. economy will weather the current global financial turmoil. On Wednesday, Wachovia Corp., which is being bought by Wells Fargo & Co., said it swung to a huge loss in the third quarter while the drugmaker Merck & Co. said its quarterly profit fell 28 percent and that it would cut more than 10 percent of its work force.
Commercial and personal property insurer Travelers Cos. said hurricane-related losses pushed its third-quarter profit down 82 percent and forced it to lower its full-year forecast.
"Oil is now highly correlated with the stock market," said Clarence Chu, a trader with market maker Hudson Capital Energy in Singapore. "People are looking to the Dow for sentiment on the economy."
Investors also are skeptical about how much of the cut will be implemented, given the history of OPEC members exceeding their production quotas. At its last meeting in September, for instance, OPEC agreed to cut production by 500,000 barrels a day, but analysts estimate that output is still more than 200,000 barrels above OPEC's own official daily target.
"There should be a short-term boost to prices when they announce a cut on Friday," Chu said. "But OPEC production has always been above their quotas, so there's a credibility problem."
Khelil's unusually outspoken comments indicate OPEC alarm at how far and how fast crude prices have fallen. While individual oil ministers sometimes express opinions on whether a cut is in order ahead of their meetings, OPEC officials rarely speak so clearly ahead of any decision by the full ministerial gathering.
OPEC called for an emergency meeting a month before their regularly scheduled conference in December, then moved that up another month as crude plunged.
They're in a bit of panic," said trader and analyst Stephen Schork. "They underestimated what happens when the bubble implodes."
Iran and Venezuela, which traditionally push for higher prices, have a slimmer margin of profit than some others because their oil is heavier and more sulfurous, meaning it sells for less than benchmark crude. Going into this meeting, they again are setting the price yardstick relatively high _ Iran is looking for a price of $100 a barrel, and Venezuela at $80-$90.
In contrast, OPEC heavyweight Saudi Arabia, which can produce for substantially less, traditionally acts as a brake to demands of deep production cuts. But considering the magnitude of oil price erosion, OPEC's No. 1 producer, might be compelled to bow to pressure from OPEC price hawks on Friday.
One possible compromise scenario is a large-scale output cut in two stages _ one on Friday and a second, if necessary, when the group meets Dec. 17 in Oran, Algeria.
If OPEC does implement substantial output reductions, "I still think that the price will remain weak but at least it will stabilize," says London-based analyst John Hall.
But he warns a cut that goes too far, too fast could backfire unless world supply stocks of oil are allowed to build first.
"We need to see world stocks higher so we can deal with supply disruptions without creating price volatility," says Hall.
There is a danger, he said, that a sudden spike in crude prices would further stoke economic recession _ and do serious harm to OPEC and non-OPEC nations alike.