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Testing time ahead for Opec

Market woes and procedural headaches ahead as cartel meets in Vienna

WITH Brent futures sailing almost 50% above the range Saudi Arabia considers healthy and evidence of demand erosion beginning to mount, Opec faces one its trickiest meetings in years in Vienna on 8 June.

And while it debates the signal it sends to an inflated market, Opec has other problems on its hands. Qatar’s recognition of the rebel Libyan government, the Transitional National Council (TNC), is causing a procedural headache. It will grow more severe if the TNC claims an official place in Vienna.

A source within the TNC said it hoped to be present at the meeting. The rebels have their sympathisers within Opec, but the group cannot give it official status unless the United Nations, or Austria, does first. It is safe to say the Qatari delegation will not be seated next to the one from Tripoli, whose government the emirate no longer recognises. At least Shokri Ghanem, who at last appeared to announce his defection from Libya at a press conference in Rome on 1 June, will not be attending the meeting.

Then there’s Iran. President Mahmoud Ahmadinejad will not be in Vienna, despite having taken over his country’s oil ministry and his earlier plans to attend the meeting. But Iran holds Opec’s rotating presidency, so an internal conflict in Tehran that many analysts think could see Ahmadinejad turfed out of power could hang over events in Vienna, too.

The politics – and an international media presence on a par with the Opec’s meetings of the 1970s – threaten to overshadow the more pressing business, as the cartel seeks to soothe the market.

But this could be most difficult of all. Opec’s own forecasts see demand for its crude rising between the second and third quarters of this year by 2 million barrels a day (b/d). If the group accepts this forecast, and is genuinely keen to prick the oil-price bubble, it will offer the market a clear signal by lifting quotas.

Market ups the ante

That has not been agreed yet. “Unlike previous meetings, there is no framework agreement in place,” said Bill Farren-Price, chief executive of consultancy Petroleum Policy Intelligence. “Everything is likely to hang on what happens in the room on the day.”

The market is certainly upping the ante. After a dip in recent weeks, on 2 June Brent futures in London June were back up above $115 a barrel, partly in response to a weakening of the dollar against the euro. The absence of Libya’s oil from the market and worries about the politics in Iran and Yemen have also added momentum to the market.

Such prices worry the world’s biggest producer as much as they make it rich.

Prince Alwaleed bin Talal, a nephew of Saudi Arabia’s King Abdullah, reiterated his country’s view last week in an interview with Bloomberg. “We don’t want the West to go and find alternatives,” he said. “The higher the price of oil goes, the more they have incentives to go and find alternatives.” A range of $70 to $80 a barrel remains the kingdom’s target, he said.

Opec’s softest approach to bring prices back in line would be to formalise existing production levels, which are well above the targets agreed in Oran, Algeria in 2008 and introduced in January 2009. In April, Opec output was 29 million barrels a day (b/d). Including Iraqi output of 2.65 million b/d, which was not part of the Oran quota agreement, Opec is now producing about 1.5 million b/d above its January 2009 baseline.

Shaky demand?

A more aggressive decision, also up for discussion, would be to lift quotas by up to 2.5 million b/d against the January baseline, which would take total output to 30 million b/d.

Even that may not be enough to ease prices, if Opec’s demand forecasts for the third quarter hold true.

But demand in third quarter could get shaky. The data on consumption, especially in the rich countries of the OECD, is already starting to look bearish.

In the US, the Federal Highway Administration, a division of the Department of Transportation, said that miles driven in March were down by 1.4% compared with the same month in 2010. Fuel prices hovering close to $4 per US gallon are hitting car owners, just as the driving season approaches. And Opec will not need reminding that US crude oil stocks, at more than 370 million barrels, are well above seasonal and historical norms.

In the UK, demand is also on the way down. The Department of Energy and Climate Change’s most recent data show a year-on-year 1.6% fall in petroleum consumption in March. Vehicle fuel was down 3.5%.

All of this confirms what the International Energy Agency said last month, that high prices could hit global growth in consumption.

Worryingly for producers, however, demand destruction is only obvious once it has already happened.

Throw in the imminent end of the Federal Reserve’s quantitative easing, which has sent speculator cash flooding into commodity markets, and there are grounds to expect a softening of oil prices anyway. Demand destruction could turn that into a rout.

So Opec’s decision on its quotas next week carries risks. If it believes its own forecasts, it should be raising production targets – but might do so just as consumption starts to go into freefall, 2008-style.

But if it is worried about a slowdown in economic growth on the back of high prices, or by emerging evidence of demand erosion, then Opec will ignore its own demand projections and hold production steady – and risk propelling the market into a new bull run. Another spike in prices beyond where the market is now would surely do even more damage the global economy, over which Opec’s influence is once again as great as ever.

 

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