Oil Prices Could be Ready to Rally if History is Any Indication

By Jason Simpkins
Associate Editor
Money Morning

Last year's 54% drop in oil prices may have set the table for a rally similar to the one experienced in 1999, when prices doubled after a similar decline.

The so-called "forward curve of futures contracts" traded on the New York Mercantile Exchange suggests prices will rise 28% this year, according to Bloomberg News.

The current curve looks almost the same as it did 10 years ago, when Russia's default drove oil prices to drop as low as $10.82 a barrel in late December 1998 – a decline of nearly 40% from where they began that year. 

At that time, the Organization of Petroleum Exporting Countries (OPEC) responded by cutting output by 1.71 million barrels per day (bpd), an amount equal to 7% of the group's total supply, setting the stage for a 1999 rally in which prices more than doubled.

Fast forward to the present. OPEC, having witnessed oil prices plunge from a record high $147 a barrel in July to just over $30 a barrel at the end of December – an astonishing 80% decline – OPEC has pledged to slash its total output by 9%.

The cartel, which controls about 40% of the world's oil production, on Dec. 17 pledged to cut production by a record 2.2 million bpd starting in January. Combined with previous cuts announced in October, the pledged output reduction totaled 4.2 million bpd, or 5% of global oil supply.

However, even with the announcement, some analysts were skeptical that member nations would follow through with the planned cuts.

At this point, it doesn't appear that the cartel is bluffing.

OPEC oil supply fell in December for a fourth consecutive month as members implemented a deal to cut output, a Reuters survey showed yesterday (Tuesday).

OPEC crude supplies fell to 30.6 million bpd in December from 30.75 million bpd in November, according to the survey that included oil firms, OPEC officials and industry analysts.

The survey also found that OPEC countries pumped 27.36 million bpd in December, down from 27.62 million bpd in November.  That means the group has met virtually all of its pledge to lower supply to 27.3 million bpd from Nov. 1.

In addition, Angola, Qatar Iran and Kuwait all announced further cuts to production this week.

Kuwait will cut oil supply by 10% from Jan. 22 to buyers in the United States and Europe. The country has pledged to reduce output to 2.22 million bpd in line with OPEC's new quotas. The country pumped around 2.45 million bpd in December.

Qatar will reduce shipments of oil sold under long-term contracts by as much as 6% in February, compared with 5% in January.

Iran has told at least two buyers that term supplies would be cut by 14% in January, sources with the customers told Reuters.

Sonangol EP, Angola's state-owned oil company, has also asked operators such as Exxon Mobil Corp. (XOM) and BP PLC (ADR: BP) to cut crude production to comply with the OPEC quota.

Saudi Arabia, OPEC's largest producer, is expected to release its allocations for February, as early as this week.

"Any clear sign from OPEC producers of compliance to announced cuts will, at a minimum, put a floor in prices," Jonathan Kornafel, Asia Director of Hudson Capital Energy LLC, told Reuters. "The larger the act of compliance, the more likely we will see a sustained rally in crude prices."

OPEC said Monday yet another extraordinary meeting will be held in Kuwait in February to discuss oil prices. Its 152nd regularly scheduled meeting is then set for March 15 in Vienna.

News and Related Story Links:

• Bloomberg:
  Oil Curve Steeper Than '99 Shows Possible Gain in '09

• Reuters:
  OPEC makes virtually all of pledged supply cut: survey

• Money Morning:
  Why Crude Oil Will Present Investors with a Golden Opportunity in 2009

• Money Morning:
  OPEC Production Cut Fails to Inspire Oil Market; Oil Drops to Four-Year Low