The OPEC Quota Tease

Jim Brown
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Only a day after I wrote about OPEC laughing at the please from the IEA and others to produce more oil a strange thing happened. OPEC suddenly mentioned raising their quotas at the June meeting. Did OPEC undergo a heart transplant or are they being crafty like a fox?

Out of the blue a week after President Obama called on OPEC to produce more oil to push fuel prices higher and the Director of the IEA asked them to produce more even if it was the heavy sour crude, an OPEC delegate suggested they will raise their production quotas at the June meeting. Did hell just freeze over?

Actually this is a perfect scenario for OPEC. They are being demonized in the press for pushing prices higher and all the while they continue to claim the oil markets are well supplied. In reality they are actually well supplied with the exception of light sweet crude. Those supplies are tight and will remain tight until well after the Libyan problem ends. However, overall there is plenty of oil in inventory. In fact U.S. inventories at 366.5 million barrels are only two million below a two year high.

OPEC is being demonized despite the high inventories. Saudi made a promise to the U.S. and the rest of world to keep the markets well supplied and claimed they tried to keep that promise by pumping more oil when Libyan production ended but nobody wanted to buy it. The blended oil they tried to supply was light but not sweet. It was better than their normal grades but still not as good as Libya's. Within a couple weeks they said they had cut production because there were no buyers.

Despite the Saudi try to fill the gap the prices kept rising. Apparently Saudi's failed efforts to keep the price down has led them to push for a change in the quotas in order to make a statement on production and price. Riyadh was one of the countries that decided against an emergency meeting to discuss quotas when the Libyan outage occurred. They probably did this in hopes of selling more oil on their own in a unilateral effort to prove they were still the big dog in OPEC and to collect a few more bucks for the treasury.

All those efforts failed and OPEC is being assailed on all sides by countries clamoring for some relief from prices. OPEC has come up with the perfect plan to remedy this.

OPEC cut production quotas by 4.5 million barrels per day in December 2008. However, they are currently only around 50% compliant with their own quotas and they are producing more than two million barrels a day over quota.

Apparently OPEC has decided to discuss the quota system and reevaluate their quotas at the June meeting. This is not official yet but comments are starting to surface that the current quota system is obsolete and needs revision. In reality it is with a third of the OPEC nations unable to even meet their reduced quotas. Others are pumping flat out while Saudi Arabia and Kuwait have excess capacity. Iraq does not have a quota and once they get their new production online it is going to be a serious problem. Iraq could double production to 5.0 mbpd by 2020 and that would require an OPEC decision on enforcing a new quota on them.

Meanwhile the OPEC plan I see developing is to revise or restructure the production quotas at the June meeting in order to "relieve price pressures around the world." While the actual changes may be total crap it will be a skillfully crafted scenario to take them out of the hot seat and turn OPEC countries into heroes.

They can announce a revision of their quotas to allow an additional 2.5 mbpd of production to ease world oil prices without pumping a single extra barrel. Since they are already producing about that much extra today a formal quota revision for 2.5 million more in production would seem to John Q Public as a solution to the world's oil crisis. Thank you OPEC!

They can also disguise this and use it to their advantage by reducing quotas on those countries that can no longer produce up to their quota and give the extra production to those countries with extra capacity. They can make a big show of the revision with press releases for every delegate and high fives all around as the leave the meetings.

However, they decide to make the change will be one monster magic trick complete with smoke and mirrors. They are not going to produce any more oil than they are producing now and when they do need the extra oil later this year they will just cheat on the new quotas.

Don't forget the quota is important for OPEC's extra capacity hoax. As long as they can say the quota is 2.5 mbpd below prior production levels it gives the impression they can actually produce at those higher levels.

For instance assume country ABC once produced at 10 mbpd at the height of their oil boom. A global recession occurred and demand slowed so OPEC cut their quota to 8 mbpd. It would appear on the surface they had 2 mbpd of excess capacity. However, if the fields are now past their peak they could be declining by 250,000 bpd per year. Assuming it has been four years since the peak their real capacity may only be 9 mbpd today. However, it still appears to be 10 mbpd because of the peak and the quota based on the peak. This is the problem with OPEC today. Many of their fields are declining but because their status inside OPEC is based on capacity and reserves NOBODY will ever willingly admit they no longer have the capacity they once did.

As a result of cheating, bluffing and misinformation that goes on inside OPEC we have no idea what their real capacity is. Any change to this quota system based on reserves and production capacity is based on untruths and misinformation.

If OPEC does decide to save the world from another recession and raise their production quotas in June it will only be for show and contain no substance. It is against their best interest to change the game. They control the market and they do not want to push prices lower regardless of what they say. They want to keep prices right on the edge of recessionary levels so they can get the highest prices for their oil without killing demand. In reality they only want to kill enough demand so it does not grow so fast it exposes their inability to produce. It is a fine line and one they are learning to walk carefully.

Jim Brown

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