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Opec production cuts { March 20 2003 } Original Source Link: (May no longer be active)
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OPEC's Production Cuts, Internal Restraints Keep Prices Stable
Feb. 26 (Bloomberg) -- In the early hours of March 20, 2003, Ali al-Naimi, Saudi Arabia's oil minister and the most influential member of OPEC, was in the shower in his Riyadh apartment when his phone rang. On the line was Claude Mandil, executive director of the International Energy Agency, a Paris-based organization of 26 industrialized countries that coordinates the release of Western oil stocks in times of emergency.
A U.S.-led coalition had crossed into Iraq that morning, and Mandil wanted to be sure that the Organization of Petroleum Exporting Countries would stand by its commitment to make up for any shortfall of oil. Mandil says al-Naimi told him OPEC would step in to fill the gap if needed.
OPEC's reaction underlines the extent to which the organization, whose 11 members from Indonesia to Venezuela pump a third of the world's oil, has reestablished its credibility, tempered internal squabbling and reined in its poorly disciplined members.
Ninety minutes after the first U.S. cruise missile hit Baghdad, Vienna-based OPEC, the Saudi oil ministry and the IEA told oil markets there would be no shortage.
Crude oil contracts for April delivery traded on the New York Mercantile Exchange, which had been falling in the week leading to the war as traders bet the conflict would be short, extended their decline: They fell 4.3 percent to $28.61 a barrel. They'd hit a high of $39.99 a barrel on Feb. 27, the highest price since 1990.
`Very Big Credit'
``Give OPEC some credit, some very big credit,'' al-Naimi, 68, said during an early morning jog along Vienna's sleepy streets after the war ended last year. ``We pumped more oil than we had to.''
The risk of a major disruption of oil supply was real, Mandil says. Thanks to OPEC, the IEA didn't recommend that its members -- who hold 4 billion barrels of oil, or 115 days of imports -- release their strategic stocks as it had done during the first Persian Gulf war in 1991.
``For years, producers and consumers were adversaries, and OPEC and the IEA were foes,'' says Mandil, whose office on the left bank of the Seine River in Paris has an unobstructed view of the Eiffel Tower. ``Today, OPEC understands it can't use oil as a weapon anymore. I don't think they'll ever do it again.''
The group's benchmark oil price -- a composite based on crude oil grades from seven countries -- has been higher than OPEC's self-imposed low of $22 a barrel for two years and averaged $28 a barrel in 2003, compared with $18 throughout the 1990s.
Oil prices in New York hit a 10-month high of $36.37 a barrel in January.
Drop in Demand
Meeting in Algiers on Feb. 10, OPEC unexpectedly agreed to cut oil quotas for the second time in less than five months and reduce its total output by about 10 percent in April because of an expected seasonal drop in demand in the second quarter.
Crude oil traded in New York gained 3.2 percent to $33.47 per barrel following the surprise decision, which was immediately denounced by U.S. Treasury Secretary John Snow. ``Higher energy prices act like a tax,'' Snow told reporters in Jacksonville, Florida.
A $5-per-barrel increase slows the global economy by raising consumer prices and depressing spending, and can shave off as much as half a percentage point of annual growth during the following one to two years, according to estimates by Deutsche Bank AG.
High oil prices have also translated into boom times for companies such as ChevronTexaco Corp., ConocoPhillips and Exxon Mobil Corp., each of which had their most profitable year ever in 2003.
Investor Benefits
Investors have benefited as well: The 13-member Amex Oil Index of global oil companies rose 38 percent during the year ended on Feb. 25.
High prices also encourage exploration in zones that would otherwise be considered uneconomical, such as Russia's Siberian north and Angola's deepwater shores. The ``oil shocks'' of the 1970s, for example, helped spur the development of the North Sea and Alaska's Prudhoe Bay.
At the same time, they created new oil regions rivaling OPEC producers and helped reduce the dependence of Western countries on OPEC oil.
``Thirty-dollar-a-barrel oil is a policy that depresses demand for oil products, stimulates non-OPEC high-cost producers and leads to more research and development into new technologies and alternative energies,'' says Edward Chow, a visiting scholar at the Washington-based Carnegie Endowment for International Peace. ``That's OPEC's trade-off.''
Sense of Complacency
OPEC's ability to keep prices higher than $28 a barrel in recent months may have created a sense of complacency at a time when the organization faces challenges that could undermine its stability, says John Waterlow, an analyst at Wood Mackenzie Consultants Ltd., an Edinburgh, Scotland-based oil consulting firm.
The first comes from within OPEC itself as members like Algeria, Libya and Nigeria increase their production capacity and Iraq returns to the international oil market.
The second comes from non-OPEC oil producers -- such as Angola, Kazakhstan and Russia -- that are taking advantage of high prices to increase output and chip away at OPEC's market share.
Adam Sieminski, Deutsche Bank's global oil strategist, says OPEC, whose members control 78 percent of the world's oil reserves, faces the difficulty of how to keep prices close to a 13- year high while stemming erosion of the group's market share.
`High Prices Forever'
``OPEC seems to think it can get away with high prices forever,'' says Sieminski. ``It's like a man jumping from a tall building and shouting, `So far, so good,' as he passes each floor. They're making a lot of money, and the temptation is strong to think high prices are permanent. I don't think they are, but it only hurts once you've hit the ground.''
OPEC's evolution began with a secret meeting in a Miami hotel room between Saudi Arabia's al-Naimi and Mexican Oil Minister Luis Tellez in 1997, says Andres Antonius, then Mexico's undersecretary of energy.
At the time, OPEC's top three producers -- Saudi Arabia, Iran and Venezuela -- were hurling accusations of quota-busting at each other.
OPEC's output that year had reached its highest since 1979: Led by Saudi Arabia, members pumped 12 percent more oil than the group's quota of 25 million barrels a day. Partly as a result, prices in New York slid from $26 a barrel at the beginning of 1997 to less than $16 a year later.
Mistimed Decision
The price drop was exacerbated by OPEC's mistimed decision in November 1997 to boost its overall output by 10 percent to bring its quota level up to the group's actual production, says Youssef Ibrahim, managing director of Strategic Energy Investment Group, a Dubai- and New York-based consultant to oil companies in the Middle East.
The decision, made in the Indonesian capital, Jakarta, proved disastrous at a time when the economic crisis in Asia led to lower demand and 1.8 million barrels of oil a day were coming back from Iraq after the United Nations eased its trade sanctions, says Ibrahim.
Prices slumped further, and in December 1998, OPEC's benchmark touched $9.13 a barrel -- the lowest price since 1986.
OPEC was unable to halt the slide because its members couldn't agree on how large an output cut each member would bear to boost prices.
Mexico -- not an OPEC member and the third-largest supplier of oil to the U.S. after Canada and Saudi Arabia -- was hurting from the price drop.
$4.8 Billion Shortfall
The Mexican government, which relies on oil for a third of its revenue, posted a $4.8 billion shortfall in its 1998 budget because of the slump.
The situation was so desperate that some smaller producers, such as Egypt, stopped exporting crude oil.
Tellez asked al-Naimi to put aside differences with his Venezuelan counterpart and curtail production so that prices would rise again, according to Antonius.
That first meeting kicked off a series of talks between Mexico and Venezuela, which eventually led Mexico to broker direct talks between the two OPEC countries.
Political changes in Iran and Venezuela helped accelerate the truce between OPEC's top three producers. Lt. Col. Hugo Chavez, who was elected in February 1999 to the Venezuelan presidency, favored restricting production to raise prices and boost revenue.
Islamic Revolution
Relations between Saudi Arabia and Iran began to thaw after the election in 1997 of cleric Mohammad Khatami to the Iranian presidency. That led in May 1999 to the first visit to Riyadh by an Iranian head of state since the Islamic revolution, Saudi officials said at the time.
The rapprochement between Iran, Saudi Arabia and Venezuela set the stage for OPEC's current policy. The three countries met in Riyadh in March 1998 and agreed to production cuts that were eventually endorsed by seven non-OPEC producers, including Mexico and Norway.
By March 1999, after three OPEC production cuts totaling 4.3 million barrels a day, the price drop had been arrested. From 12- year lows at the end of 1998, oil prices rose to as high as $27.15 in New York by November 1999.
The change was marked in March 2000 by the adoption in Caracas of the price band, an initiative put forward by Venezuela. OPEC agreed to manage production in order to keep its benchmark at $22 to $28 a barrel.
Pump More Oil
The band would act as a barometer to tell the group when it should pump more oil or less oil: OPEC would consider output adjustments if prices fell to less than $22 a barrel for 10 consecutive days or rose higher than $28 a barrel for 20 days.
``The idea for the price band grew after a study we did of oil prices,'' says Ali Rodriguez, who was Venezuela's oil minister and OPEC's secretary general at the time and now heads state-owned oil company Petroleos de Venezuela SA. ``We observed that after each high, prices fell abruptly, but the general tendency was for them to be stable or to stay within a band.''
A former Marxist revolutionary who hid in the jungle throughout the 1970s, Rodriguez played a key role at the time by forcing Petroleos de Venezuela to slash production and meet its quotas.
In January 1998, Venezuela was producing 3.4 million barrels a day -- 800,000 barrels above its OPEC quota. By October 2000, Venezuela was producing less than its quota.
To underline Venezuela's new attitude toward OPEC, Chavez organized a heads-of-state meeting in Caracas to be held in September 2000, the organization's first in 25 years.
Boom-and-Bust Swings
At that meeting, OPEC issued its new creed that said it's better for the world economy to have a price averaging $25 a barrel than boom-and-bust swings from $10 to $40.
``We succeeded in stabilizing prices in a range that OPEC considers to be fair for both consumers and producers,'' says Adnan Shihab-Eldin, OPEC's director of research. ``OPEC continues to seek this objective.''
Since March 2000, oil prices have dropped below $22 a barrel for an extended period only once: after Sept. 11, 2001. OPEC's benchmark averaged $19 for the next six months because the terrorist attacks on the U.S. curtailed air travel and cut the need for jet fuel.
The benchmark climbed back above $22 in March 2002 and hasn't fallen below OPEC's range since.
``I've never seen anything like this,'' says Pierre Terzian, an oil consultant who's been following OPEC meetings since 1971. ``The mandate oil ministers got from their political masters four years ago was to prop up the price of oil and not worry about politics. That opened OPEC's golden age.''
Benchmark Average Price
From 1987 to the mid-1990s, OPEC's benchmark average price was $18 a barrel. In 1998, it dropped to $12.40. The following year, it was $17.60.
For the past four years, it has been above OPEC's $22 level: $27.60 in 2000, $23.20 in 2001, $24.40 in 2002 and $28.20 last year. This year through Feb. 25, the average price was $29.86.
Some of the credit for OPEC's success over the past four years belongs to al-Naimi, the Saudi oil minister, Strategic Energy's Ibrahim says.
``OPEC's beginning to like the idea of high oil prices,'' he says. ``Al-Naimi has held on to his job because he's kept prices above $25. Had he failed, he'd have been kicked out.''
The Saudi technocrat, who was appointed by King Fahd in 1995, attributes OPEC's success to a newfound attention to its bottom line: prices.
`Money, Not Politics'
``OPEC ministers are now focused on money, not politics,'' al- Naimi says. ``Our customers now have the confidence and security that we will do what we say: provide a reliable supply of oil.''
One of the reasons al-Naimi is so influential within OPEC is that Saudi Arabia, which holds a quarter of the world's oil reserves, is the only country that can significantly increase its production to meet either a sudden oil shortage or an increase in demand.
It boosted production by 50 percent in 1990, for example, after Iraq's invasion of Kuwait cut off about 4 million barrels of oil a day from the world market.
Saudi Arabia currently has a capacity of 10.5 million barrels a day, according to the Energy Information Administration, a division of the U.S. Department of Energy.
In January, the country pumped 8.48 million barrels a day, according to a survey of oil companies, producers and traders compiled by Bloomberg.
In addition to al-Naimi's successes, world events have played a part in OPEC's ability to keep prices high.
`Unbelievably Savvy'
``Al-Naimi has been unbelievably savvy in his combination of action and rhetoric,'' says Edward Morse, executive adviser to Hess Energy Trading Co., an affiliate of New York-based oil company Amerada Hess Corp. ``But a lot of it was also sheer luck.''
Last year, for example, a series of disruptions within oil- producing regions curtailed production and limited supply, contributing to high prices.
Those events included civil strife in Nigeria that cut production by 13 percent in Africa's biggest oil producer, according to the EIA, and a strike by Venezuelan oil workers opposed to President Chavez that brought the country's production of 3 million barrels a day -- representing about 4 percent of world supply -- to a near standstill for two months.
Then came the war in Iraq, which cut off exports of about 2 million barrels a day.
`Credit Undeservedly'
``OPEC has taken credit undeservedly for achieving high prices,'' says the Carnegie Endowment's Chow, who was an executive at Chevron Corp. for more than 20 years.
Higher demand from oil-consuming countries also contributed to price increases last year because of record summer heat in Europe, a temporary shutdown of nuclear power plants due to safety concerns in Japan, and frigid weather from the U.S. Midwest to the Northeast, according to Klaus Rehaag, who heads the IEA's oil industry and markets division and edits its monthly oil report.
``Geopolitical risk is much higher today than it was, say, five years ago, and that's added a risk premium to the market,'' he says. ``That's helped OPEC in the past and could still help it in the future.''
OPEC's current focus is on the U.S. dollar, which has fallen 30 percent against the euro since the beginning of 2002. OPEC members, who sell their oil in dollars, need euros or yen to buy machine tools and luxury goods from Europe or cars from Japan.
Purchasing Power
At OPEC's December meeting, al-Naimi said $28 a barrel is the equivalent of $25 a barrel, considering the decline in the dollar's purchasing power.
Whatever happens around the world, not everyone is convinced that OPEC has mended its divisive ways for good, Chow says. OPEC remains a political organization that depends on governments' agreeing with each other about what's in their best interest, he says.
``Nothing has changed too much,'' he says. ``The fundamental challenges facing the cartel still exist -- and cartels are unstable by nature.''
OPEC's own members could upset its balancing act.
In Iraq, which hasn't had a quota since 1990, the U.S. occupation authority is seeking to rebuild the country's oil infrastructure and expand production. Algeria, Libya and Nigeria are asking for their quotas to be raised, seeking a greater share of OPEC's output as their production capacity increases. Venezuelan President Chavez, one of OPEC's most forceful advocates, is under pressure as he faces the prospect of a recall- type referendum. And bombings in Saudi Arabia last year highlighted OPEC's top producer's vulnerability to terrorism.
`Difficult Times'
``We recognize that the next few years will be difficult times,'' OPEC Research Director Shihab-Eldin says.
Iraq's return to world oil markets could be especially disruptive. The U.S.-appointed Iraqi Governing Council is currently in charge of oil production, and the U.S. occupation authority has decided, along with the council, to set up a provisional Iraqi government by June 30.
``We have to face the fact that Iraq must return, will return and is returning to the oil market,'' Shihab-Eldin says. ``There is nothing wrong from an OPEC point of view for making room for an important country. We don't find that's something to be feared, but it's something to be dealt with within the organization.''
The UN lifted sanctions on Iraq in May, and today the country aims to export as much oil as possible to finance its reconstruction.
A return to full production could take a while. Because of security concerns, a pipeline linking Iraq to the Mediterranean Sea in the area of Turkey, which accounted for a third of exports before the war in Iraq, has been shut since major combat operations ended.
Looting and Sabotage
Looting and sabotage in the south of the country have also hampered production.
Before the war, Iraq was producing 2.3 million barrels a day. That's about 1 million barrels less than it pumped before its 1990 invasion of neighboring Kuwait.
Ibrahim Bahr al-Ulum, Iraq's new oil minister, who was named in September by the Governing Council, told his OPEC counterparts in December that he expects oil output to reach 2.8 million barrels a day by the end of the first quarter. Exports will account for 2 million barrels a day.
Iraqi oil ministry officials have sketched plans to double output by 2010.
OPEC faces another contentious internal issue: It must review its members' quotas -- the basic mechanism the organization adopted in the 1980s to regulate production, which allocates a share of OPEC's total output to each country.
Actual Production
The group decided to lower its quota by 3.5 percent in September and by another 4 percent in February to 23.5 million barrels a day. Actual production in January, excluding Iraq, was 26.1 million barrels.
``The quota issue is the worm in OPEC's fruit,'' says Olivier Rech, an economist at the Institut Francais du Petrole, a research center near Paris. ``Reopening the talks is extremely sensitive.''
Of the 10 countries that have a quota, eight are producing more than their limit -- partly to compensate for Iraq's shortfalls, as in the case of Saudi Arabia, or because they're producing at full capacity, like Algeria, Iran and Kuwait.
Any increase in the group's quota could push prices down, while any reallocation of production from one country to another would inevitably meet opposition.
For example, Algeria, which has a quota of 782,000 barrels a day, now produces 1.17 million barrels a day -- 50 percent above its limit.
The Sahara Desert
The country, with the help of Anadarko Petroleum Corp., BP Plc and Total SA, is developing new fields in the Sahara Desert.
Officials there say they aim to boost production to 1.5 million barrels by next year and to 2 million by the end of the decade.
``That's the OPEC dilemma,'' Wood Mackenzie's Waterlow says. ``There's always the temptation for someone to cheat.''
OPEC could face another backlash from its high-price strategy. By curbing production while demand is rising, OPEC is allowing non-OPEC producers like Angola, Kazakhstan and Russia to grab a bigger slice of the market.
``OPEC is defending prices, not volumes,'' says Antoine Leurent, an oil analyst at KBC Securities in Paris. ``This means that OPEC has sacrificed its market share in order to prop up prices. That's been a great boon for other producers who've jumped on OPEC's bandwagon.''
From 1998 to 2002, OPEC's production dropped to 25 million barrels a day from 28 million barrels a day, according to estimates by Deutsche Bank. During the same period, global oil demand increased by 3.4 million barrels a day.
Mainly by Russia
The difference was made up mainly by Russia. In 1998, OPEC's share was 42 percent of the world's oil market, according to the Statistical Review of World Energy, issued annually by BP.
Output by the former Soviet Union, which includes Russia and Azerbaijan, accounted for 10 percent that year.
By 2002, OPEC's share had fallen to 38 percent, while former Soviet Union countries grabbed 13 percent, according to BP's statistics.
The battle for market share won't end soon. Russian oil production, currently at about 8.5 million barrels a day, may reach 10.5 million barrels a day by 2010, according to Wood Mackenzie. Peak Russian production could be as high as 12 million barrels a day by the end of the decade, according to the Scottish consulting firm.
Russian companies such as AO Yukos Oil Co. and OAO Rosneft have increased oil output 35 percent since 1999.
Soviet-Era Peak
The country is at least one-fifth short of its Soviet-era peak of 12.6 million barrels a day in 1987, and Yukos Chief Executive Officer Mikhail Khodorkovsky is currently in jail on charges of tax evasion and fraud. He denies the charges.
Saudi Arabia and Russia have attempted to reach common ground. In September, Crown Prince Abdullah was the highest- ranking Saudi official to visit the Kremlin since 1926, according to Russian authorities.
Even so, Russian officials have ignored OPEC's calls to limit production and have repeatedly said they consider OPEC's target price too high. In October, Russian Energy Minister Igor Yusufov said at a news conference in Moscow that he prefers oil to be $20 to $25 a barrel.
Saudi Arabia won't accept the loss of market share to producers like Russia for too long, says Deutsche Bank's Sieminski. The kingdom, he says, has a weapon at the ready: It can always use its spare oil capacity to provoke a price war, as it did in the late 1990s against Venezuela.
Conciliatory Tones
OPEC's Shihab-Eldin speaks in conciliatory tones about the Russian threat to current global oil peace.
``Russia knows very well that it's in its interest that stability is maintained and it cannot go on forever expecting that OPEC will do the job alone,'' he says. ``If we don't cooperate together, we will go back to the lessons no one wants to repeat.''
Meanwhile, Shihab-Eldin, whatever his rhetoric, keeps a close eye on the looming competition. In his office at OPEC's Vienna headquarters overlooking the Danube River, he keeps a graph pinned to the wall behind his desk. It's a chart of Russian oil production.
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