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Oil in a Week (Decision to Cut Output & OPEC)

Walid Khadduri
Al-Hayat - 27/10/08/

http://english.daralhayat.com/business/10-2008/Article-20081027-3e34c4c8-c0a8-10ed-011c-4d165d73bb57/story.html


The decision to reschedule OPEC's extraordinary ministerial meeting from November 18 to October 24 was the toughest for the organization these days. The date signaled for markets that OPEC does not believe there is an urgent need that justifies holding an immediate extraordinary meeting at a time when prices are falling on a daily basis.

The extraordinary meeting was held just days before the American presidential elections and in concurrence with a major financial crisis hitting American and international markets. This places OPEC's decision under the microscope and presents it as an opportunity for politicians and pundits in industrial nations who wish to talk about the lack of cooperation on the side of oil-producing nations with the difficult resolutions made by industrial countries to stabilize the financial system. Criticism of OPEC is likely to increase as a result of the decision by the ministerial meeting to cut output, especially at this phase when industrial nations consider falling oil prices to be the only positive indicator of possible global economic stability following the US subprime mortgage crisis and the ensuing massive losses.

What exactly does OPEC's decision to cut output mean?
OPEC has long adopted a policy of balancing demand and supply in international oil markets. Since a significant drop has been noted in demand over the past few months, the organization wanted to ensure the equilibrium by cutting supply in a manner that corresponds with the decline in demand. The problem is that there is a variation in the figures and forecasts about the decline in demand published by the International Energy Agency and OPEC. In fact, the published numbers vary from one country to another within OPEC itself.

Naturally, there are those who point to the rapid decline of prices since August. Just as the price increase in the first half of 2008 was rapid and spectacular, so seems to be the case of decline now. If this means anything, it implies that the oil pricing system decided in free markets in New York and London on the basis of future prices of oil while severely lacking transparency as a result of speculations and monopolies, requires numerous reforms and control systems like the rest of the international money system or else there will be no end for this vicious cycle of rapidly rising prices followed by a rapid bust.
Some of the tough questions discussed by the ministerial meeting were: how deep should be the output cut? What is the objective of the cut? Is it to balance demand and supply, to cut falling prices, to attempt to stabilize prices within the range of $70 to $90, or returning them to $100 and above as demanded by Iran and Venezuela, even if such a proposal enjoyed no support from any other states?

It is noted that there exists an oil cycle of approximately ten years for the meltdown of prices in the recent past, even when causes varied in each case. The collapse of prices in 1986 was caused by the increasing supply from outside OPEC whereas the second collapse in 1998 was caused by the Asian economic crisis and the decline in demand there at a time when OPEC increased output (the Jakarta resolution of 1997). The current price meltdown, on the other hand, is caused by the decline in demand as a result of the rapid and massive increase in prices during the first two half of the year in addition to the declining demand as a result of the global financial crisis and the lack of confidence in the proposed economic solutions.

The question here is: how does OPEC evaluate the current global economic crisis. Should it focus on its ability to inject trillions of dollars to stop the global financial meltdown, especially as it appears that the upward and downward fluctuations in the markets over the past few days seem to fall within treatable levels, or should it consider this a historic meltdown and deal with it accordingly?

The problem facing OPEC right now lies in the fact that two basic factors are pushing prices downwards: the first is the consumer response to cut demand as a result of high prices in recent months; the second is the declining rates of oil spending and consumption as a result of the global financial crisis. These factors require that OPEC cut supplies to establish balance between demand and supply, but doubts lurk about the ability of the organization to end the trend of falling prices with a single resolution in such a gloomy economic environment.