OPEC Production Cut Up in the Air as Members to Clash Over Oil Prices

By Jason Simpkins
Associate Editor
Money Morning

In the face of the worst worldwide financial crisis since the Great Depression, the Organization of Petroleum Exporting Countries (OPEC) is expected to cut crude-oil output and raise prices at an emergency meeting in Vienna tomorrow (Friday). But even with crude oil prices down more than 50% from their July record highs, friction between cartel members has analysts wondering just how big the prospective cut will actually be.

Oil prices continued their downward slide yesterday (Wednesday), dropping $5.22 a barrel, or 7.2%, to $66.96. Prices are down about 55% from the record high of $147.27 a barrel reached July 11. Crude's dramatic plunge now has OPEC members scrambling to cut production and at least stabilize prices. The cartel members all agree that the outlook for demand has declined significantly. But there is a considerable amount of discord over the size of that cut.

OPEC members called for the emergency meeting – the cartel had originally been set to meeting Nov. 18 – so it might settle any of the production disputes between cartel members, even as it prepares for a global recession.

That will be easier said than done. Different OPEC countries have different economic models – with different oil-pricing floors – to keep their trade balances in check. PFC Energy estimates that Qatar, which imports just about $15 billion worth of goods a year and has little government spending, only needs oil to trade at $10 a barrel to keep its trade balance from sliding into the red.

At the other end of the spectrum, however, are Iran and Venezuela, which rely heavily on petrodollars to finance social programs and infrastructure development, meaning they need crude oil to trade at $100 a barrel or better. Little wonder those two countries have been the most vocal proponents of a large cut in production.

However, OPEC's most productive and influential member, Saudi Arabia, has based its budget on an average oil price of $50 a barrel, according to PFC. The Saudi government in Riyadh also has political motives for wanting to keep oil prices in check. Saudi policymakers have routinely expressed concern about high oil prices leading to demand destruction. Oil is the primary source of energy in the developed world and the world's leading crude producer doesn't want that to change.

"We are concerned about the permanent destruction of demand," a senior Saudi official told BusinessWeek. "Those who buy hybrid vehicles are not going back to SUVs."

Iran and Venezuela don't have the time, or the money, to worry about oil demand a decade from now.

"The divisions arise in OPEC because what countries need and want varies," Gareth Lewis-Davies, an oil analyst at Dresdner Kleinwort Ltd., told Bloomberg News.. "The Saudis are playing a long-term political game. Other countries have higher costs."

Oil accounts for 50% of Venezuela's government revenue and 95% of the country's export earnings. Crude exports make up 85% of the Iranian government's revenue.

"Venezuelan fiscal profligacy and its huge off-budget populist programs have left it very little room for error," the PFC report said.

Iran and Venezuela also have political agendas. Iranian President Mahmoud Ahmadinejad and Venezuelan President Hugo Chavez both use oil as a bargaining chip and a rhetorical weapon in their venomous assaults on the United States. But Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates are all on much better terms with Washington, and don't want to alienate a new U.S. administration or jeopardize relations with their best customer.

The division within OPEC has been particularly evident over the past few months. At a June 22 meeting in the port city of Jeddah, as the price of oil skyrocketed, Saudi officials unilaterally announced a 200,000 barrel-per-day (bpd) increase in production on top of a 300,000 bpd hike issued just a few weeks earlier.

Later, as OPEC members rallied to halt oil's price decline in September, Saudi Arabia remained hesitate to accommodate the hawkish chorus. Instead, Riyadh conceded to vague language promising a production cut, but offered private assurances to customers that it had no real intention of honoring it.

"Except for Iraq and new members who are outside the OPEC quota, the rest of the members should produce in the framework of their committed quota," Iran's oil ministry news agency Shana quoted Algerian Oil Minister and OPEC President Chakib Khelil as saying.

Saudi Arabia produced 9.45 million barrels a day in September, according to Bloomberg estimates. Its output target is set at 8.94 million barrels.

Iran's energy minister said earlier this week that OPEC could slash output quotas by 2.5 million barrels a day. But, again, there's a question of whether or not Saudi Arabia will accept such a sizeable reduction.

"I don't think we'll see a 2 million-barrel cut, given the reaction that this will have both by the market and by politicians," John Sfakianakis, chief economist at The Saudi British Bank in Riyadh, told Bloomberg.

Regardless of what Iran, Venezuela and others desire in the way of a production cut, the ultimate decision will rest with Saudi Arabia, which is the world leader in oil reserves, with about 260 billion barrels of oil in the ground. Iran is third with 136 billion barrels in reserves, and Venezuela is seventh with just 80 billion barrels.

Sfakianakis expects a 1 million-barrel a day production cut, Friday.

News and Related Story Links:

• PFC Energy:
  Oil Market and Countries Strategies Group

• BusinessWeek:
  Saudi Oil, OPEC's Ire.

• Wikipedia:
  Hugo Chavez.

• Wikipedia:
  Chakib Khelil.

• Washington Post:
  Tough choices for Venezuela as oil prices fall

• Bloomberg:
  OPEC Risks Split on Cuts as Economies Reel, Oil Drops

• Money Morning:
  Saudi Arabia Hesitant to Join OPEC in Production Cut.

• Wikipedia:
  Mahmoud Ahmadinejad.