OPEC Divided Against Itself on Oil Production Strategy

Iraq's Minister of Oil and President ofOPEC remained divided on Wednesday on the eve of one of its most important meetings for years, Saudi Arabia still spreading a drop in production of the cartel, while Iran called to respond to the growing oversupply in the oil market.

“All the experts believe that there is an oversupply in the oil market, and next year it will be even more oversupplied,” said on Wednesday the Iranian Oil Minister Bijan Namdar Zanganeh, on arrival in the Austrian capital.

Crude oil fell more than 30% since the spring, falling to their lowest levels in four years, due to a growing imbalance between supply and demand.

On the one hand, global production has swelled with the surge of US oil supply, through the exploitation of unconventional resources such as oil shale.

And besides, the expected increase in global demand for black gold have been revised downwards in recent months, mainly because of the weakening of growth in major consumption areas, such as Europe and China.

In this context, Mr. Zanganeh stressed that “we need to discuss, confront our views and make a decision to control the market.”

Talking with non-members

In addition, “to handle this situation, we need a contribution of off-OPEC producing countries,” he added, after a meeting between ministers of Venezuela and Saudi Arabia, two OPEC countries together with Russia and Mexico, two non-members of the cartel.

If no coordinated drop in production had been decided in these discussions of four, the four countries had agreed to meet again in February, and the Russian state-owned company Rosneft announced in the wake of a symbolic drop of its own production (25,000 barrels per day only, a drop of water for Russia, which produces about 11 million barrels per day).

“We must try to improve the course as much as possible taking into account the new market situation”, had already pleaded Mr. Zanganeh ten days ago, after interviews with Venezuela, an open supporter of a coordinated slow-down production.

But OPEC remains divided on how to deal with falling prices. The ministers of the twelve states of the organization in Vienna on Thursday should review their collective production ceiling, fixed for three years at 30 million barrels per day, almost a third of daily crude oil extracted in the world.

On Wednesday, the Saudi Oil Minister Ali al-Nuaimi hinted that he would defend a continuation of the ceiling of OPEC, showering the hopes of a reduction in the ceiling.

Better respect the ceiling

“The market will eventually stabilize,” were the first words of the oil minister to reporters, according to comments reported by Dow Jones Newswires.

Given these statements, “there is not much chance that a reduction of the production is decided at the OPEC meeting,” commented analysts at Commerzbank bank.

But failing to agree on such a measure, OPEC, whose actual production far exceeds this limit, could at least commit to apply more discipline, they predicted, explaining that the minister Saudi “corroborate our view that OPEC is simply content to better meet its current ceiling.”

In October, OPEC production totaled 30.6 million barrels per day, according to calculations by the International Energy Agency, and 30.3 million other estimates cited by the cartel.

In this context, oil prices remained Wednesday close to their lowest levels in four years with recently. In London, Brent crude was up 39 cents to $78.72 early Wednesday morning, while US crude barrel (WTI) regained 15 cents to $74.24, after touching the day before a new low since 2010.

Is OPEC still relevant?

This meeting is eagerly awaited because the financial community is questioning more and more about OPEC’s ability to balance global oil supply and demand. Since the summer, crude oil prices plummeting from US $ 115 per barrel to$ 75, a decrease of 35%.

Global oil demand is currently estimated at 91 million barrels per day. Production of non-aligned countries, that is to say, not members of OPEC, is 62 million barrels. To play its role of last resort and synchronize supply and demand, OPEC should limit its production to 29 million barrels per day, said Luc Vallée, chief economist at Laurentian Bank Securities (LBS). Currently, the OPEC production ceiling is 30 million barrels, but actual production to be between 30.5 and 31 million barrels.

“Although there are some markets where we accept the existence of a cartel, OPEC has managed to maintain this status over the years, in part because it is the state that controls this economic sector in most member countries, but also because it has managed to maintain the often fragile balance between supply and demand,” says Luc Vallée. But as the cartel now less than a third of global production, its position is becoming increasingly precarious, according to observers.

OPEC should still meet the expectations on Thursday and announce production cuts, says Mr. Vallée. The objective will be to keep the price of oil between $75 and $85. Although it hurts more the OPEC countries that need a higher price to fund social programs, it is a necessary evil, according to economist of LBS.

The purpose of a price between $75 and $85 is also intended to discourage non-aligned producers, including the United States. US production, because of the development of shale oil increased by 1 million barrels per day year-on-year over the last five years, notes Mr. Vallée.

In discussing the level of OPEC production, all eyes invariably turn to Saudi Arabia. “But it did nothing to slow the fall in the price in the last month. It is that the Saudis wanted to raise awareness and encourage smaller producers to participate in the cartel cuts,” said Tom Nelson, Investec Global Energy Fund manager in an interview with CNBC.

For him, the Thursday meeting will be revealing as to the relevance of OPEC. “The markets want to see if OPEC still works, if it will cut its production and if it will accompany the gesture of a coherent statement demonstrating that the cartel members always stand together,” he said.

As OPEC refuses to cut production, prices fall

At its meeting of November 27, OPEC decided to maintain unchanged its oil production quota. The twelve members of the Organization of Petroleum Exporting Countries (OPEC) finally followed the “line” defended in recent months by Saudi Arabia. After two days of informal meetings and five hours of discussion in plenary on Thursday 27 November, in Vienna, they decided not to tighten the valves. The official quota of 30 million barrels per day – they set it three years ago when the price of Brent was $100 – is maintained.

Oil markets, that had started to worry later in the day, quickly sanctioned the decision. The price of oil fell in the day to levels not seen since mid-2010: under $72 for Brent and even $67 West Texas Intermediate (WTI) in New York. Prices fell by nearly 35% since mid-June.

This decision is not a surprise. Before the summit, the six states of the Gulf Cooperation Council (Saudi Arabia, Kuwait, UAE, Qatar, Bahrain, Oman) had agreed to refuse any decrease in the quota. Also, remember the words of the Saudi oil minister Ali al-Naïmi, who said the day before that he would leave play of supply and demand to set prices and that “the market will stabilize itself.” He therefore welcomed “the right decision” after the meeting, the largest since that of Oran in December 2008, when the financial crisis knocked down oil prices from $147 during the summer to $35 in December.

Several OPEC members, including Venezuela and Iran, however, supported lowering the quota to raise prices and avoid large fiscal deficits. But these “hawks” also had a concern: to preserve the unity of the cartel. The unity is saved, but the cartel has also shown the limits of its power. The organization has not even invited its members to respect the quota of 30 million barrels, since its members pump between 500,000 and a million barrels more, according to estimates.

Oil companies suffer on the Exchange

OPEC, which provides only a third of global output, will not only be the only one to bear the weight of the adjustment. The day before the meeting in Vienna, Saudi Arabia and Venezuela had made calls for Russians and Mexicans to be present. In vain. The Saudis see a very dim view of the sharp increase in US production for two years. “Why Saudi Arabia should reduce its production? The United States is also a major producer now. Should they cut their production?” questioned al-Naïmi on Wednesday.

For how long will the downward course prevail?

The International Energy Agency (IEA) estimates that the situation is expected to last until the end of the first half of 2015, due to oversupply in the market. From the supply side, the rise in US production is undeniable. With their shale oil, the United States already produce 9 million barrels per day and are close to Saudi Arabia and Russia. From the demand side, Europe and major emerging economies, including China, do not give tangible signs of economic recovery.

Some experts believe, however, that there is no glut on the market. Having a security cushion seat between 2 and 4 million barrels is not excessive when you consider the political and economic fragility of large countries such as Iraq, Libya, Venezuela and Nigeria, where the campaign for the presidential election in February 2015 leads to a strong resurgence of violence.

The decision of OPEC had another consequence: a sharp decline in the market price of European oil companies. Shortly after the announcement of the Saudi and Kuwaiti oil ministers, Total lost 3.11% (to 46.345 euros) in Paris, Royal Dutch Shell 3.91% and BP 2.76% in London. Statoil fell by 4.35% in Oslo and Eni gave up 2.20% in Milan.

This weakness in oil prices also affects the currency of large producing countries such as the Norwegian krone and especially the Russian ruble.

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