Why turning off oil taps?

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Last updated at: (Beijing Time) Friday, April 02, 2004

Why turning off oil taps?

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With the world crude oil prices hovering around a 13-year high, the Organization of Petroleum Exporting Countries (OPEC) announced Wednesday that it would go on with a production cut effective from April 1, brushing aside consumers' worry about a subsequent price surge.

Earlier this year, OPEC ministers agreed in Algeria to cut output by one million barrels per day, which will come into force on April 1. This decision initially sent shock waves across the world and pushed the oil price to new highs.

Despite the current price spike, OPEC still chose to stay the course, a move seen by analysts as driven by four underlying concerns, a seasonal demand lull in spring, some members' actual output above quotas, eroded profits by a weak dollar and a volatile speculative market.

SEASONAL DEMAND DROP JUSTIFIES OUTPUT CURBS

The global demand for oil usually slides to a seasonal low from April to June every year, which constitutes the main rationale forOPEC to tighten its grip on output.

According to the organization's estimates, global energy demand is expected to decline 2.5 million bpd in the second season, and this leads to a surplus of 400 million bpd, potentially setting the stage for a tumbling price. This runs counter to OPEC's principle of sustaining stable oil prices.

For example, after an inert winter, oil demand in the United States, the world top oil consumer, only soars at the end of May when 40 percent of global gasoline supply is devoured by the country's forthcoming driving season.

Taking a global view, the sliding demand momentum could only be checked when traveling spree kicks off in June.

OUTPUT ABOVE QUOTAS DEMANDS SUPPLY CUT

Although OPEC has enacted quotas limits, the organization lays a loose grip on members to supervise their quotas implementation. It is estimated that the actual production surpasses the 24.5 million bpd ceiling by 1,500,000 to 1,700,000 barrels.

Producing more oil above quotas limits bears fruit in two ways. One is to offset exporting losses incurred by lower prices during a lackluster market, and the other is to garner more profits facing a strong demand.

Except Iraq, which stays outside the quotas accord, many OPEC countries are taking advantage of the current price spike by pumping oil above quotas limits.

Take OPEC powerhouse Saudi Arabia as an example. According to an independent energy consultant, Saudi benefits from more output combined with higher oil prices to meet its ever-increasing expenditures.

To make things worse, a vicious cycle beckons when OPEC scales down limits to curtail oversupply while individual members again make the leap over the bar.

WEAK DOLLAR ERODES PROFITS

Although oil prices have been riding the wave to hit a 13-year high, OPEC still saw its profits eroded by a weak dollar. Since oil is traded only in dollars, and the recent decline in dollar's value has made the price increase partly nominal.

Oil profits in dollars comprise over 90 percent of many OPEC members' budget, therefore a potential write-off of profits sent shivers down the spines of many oil exporting countries.

With the dollar's depreciation momentum showing no sigh of abating, OPEC believed its decision to slash production is justified to simply maintain the profit level.

SPECULATIVE MARKETS PUSH PRICES HIGH

OPEC argues that the speculative markets should also share the blame for pushing oil prices high.

OPEC President Purnomo Yusgiantoro said: "notwithstanding the prevailing high prices, crude markets remain more than well supplied," which actually ruled out the possibility of a under-supply market holding prices high.

Many analysts echoed this view. One expert of a leading US energy consultancy estimated that speculative funds have invested 15 billion US dollars in oil futures contracts in New York and London, a decision which could encourage speculators to stay long on oil markets.

And this remains a potential nightmare for OPEC, because a possible capital flight could touch off a wave of selling off, which would send the oil prices into a downward spiral.

RIFT WITHIN OPEC

In the run-up to the announcement of a production cut, divergence drove a wedge into the once-solidary organization, with Saudi Arabia backing an immediate output restraints while Kuwait and the United Arab Emirates (UAE) considered a delay.

The unusual rift among OPEC members raised speculation that the United States is now shifting its diplomatic target from Saudi Arabia to Kuwait and the UAE for cheaper fuel.

If OPEC is determined to enforce the production cut to the letter, analysts feel safe to predict the oil prices would soar above the psychologically important threshold of 40 dollars.

And if that be the case, the prospects of the oil market would remain volatile, which defies any prediction.

Source: Xinhua

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