<Global economic weakness has effectively yielded an OPEC tax cut, however. The price of the North American benchmark West Texas Intermediate has been testing the $20 mark and, in some instances, has fallen below it. A sustained decline in crude oil prices would be very beneficial for a U.S. economy that needs all the stimulus it can get. Lower crude prices inject additional purchasing power into the economy and, in addition, would particularly benefit low-income households, who tend to spend a higher share of their income on energy. These low-income households, in turn, have a higher propensity to consume and thus are more likely to spend the additional funds available to them as a result of a lower energy bill.
OPEC faces some formidable obstacles if it is to halt the recent slide in the price of crude oil. There are no signs that the global economy is improving. Thus, weak demand will keep a lid on prices for some time to come. In addition, the cartel already has difficulties enforcing its quotas. Cheating on official production quotas is rampant, and overproduction is estimated to range between 1 and 1.5 million bpd. As further cuts are contemplated, the temptation to cheat only grows as members seek to benefit from higher prices, while at the same time boosting output and market share.>
The failure of agreement leads to this ..Dismal investigates it further..
The failure of OPEC ministers to secure the cooperation of non-OPEC members to restrict crude oil supplies is good news for oil importing countries and raises the question of whether OPEC is losing its edge. The non-member backing of OPEC's production cut is a prerequisite for any reduction in production quotas to be effective in boosting prices. Without such backing, a reduction in OPEC quotas would only reduce the cartel's market share without lending any support to prices.
The meeting of OPEC oil ministers has raised more questions than answers. OPEC has decided to defer any decision regarding a cut in production quotas, as it has failed to win support of key non-OPEC producers, most notably Russia, Norway and Mexico. The cartel will cut output by up to 1.5 million barrels per day (bpd) or roughly 6% starting on January 1, but only if OPEC's main competitors agree to a proportionate cut in output. OPEC expects nonmembers to cut production by a combined 500,000 bpd.
The demands of the cartel have met with resistance by producers outside OPEC, with only Russia offering a token reduction so small it could be construed as an affront against OPEC. Despite intense lobbying by OPEC, no agreement could be reached suggesting that future cooperation is not likely. Oil producers outside of OPEC do not depend as desperately on oil revenues and can live well with crude prices around $20 per barrel.
The absence of any agreement means that energy prices will trend sharply lower. Lower energy prices provide a much-needed economic stimulus for the U.S. economy. With lower energy bills in store, consumers will be able to spend on items other than energy, thus increasing the economy's purchasing power. The end result is that funds that have been traditionally sent overseas to foreign producers resulting from artificially high crude prices will remain in the domestic economy.
Weak global demand will remain the driving force in the oil market and will exert additional persistent downward pressure on crude prices. However, it is now also conceivable that OPEC's failure to secure cooperation by non-OPEC countries could result in a price war. In this scenario, no production cut at all would take place, and the price of crude oil would collapse. Naturally, such a price war would come at the detriment of oil producers both within and outside OPEC. It would be in the interest only of oil-importing countries, but it highlights the pitfalls involved with any inherently unstable cartel arrangement.
Also, the disagreement between OPEC and non-members should not detract attention from the differences within OPEC itself. The cartel has been unable to enforce its own current quotas and cheating has been rampant. Even if yesterday's meeting had yielded a definitive decision to cut official quotas, rampant cheating would mean a substantially smaller reduction of actual output. With rapidly growing spare capacity, the temptation to cheat and to increase market share at a rival's expense will only grow.
All this is exceptionally good news for oil-consuming nations, be it emerging market economies or industrialized nations. OPEC has lost its grip on world oil markets, and the cartel is unable to halt the slide of crude oil prices. OPEC's discipline is eroding quickly, and the cartel has lost its ability to control supplies. The recent failure to win the backing of non-OPEC countries and the continuing overproduction demonstrate clearly that the period that allowed OPEC to increase prices during better economic times earlier this year has quickly come to a close.
Compliance with quotas and discipline are the first casualties of slower demand for crude oil in the face of economic adversity. As a result, oil prices will fall well below $20 per barrel of the North American benchmark West Texas Intermediate. They will likely remain there until demand picks up with economic recovery in the second half of 2002.
Iqbal Latif
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