OPEC Faced With A Challenge

Jim Brown
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As the June 8th OPEC production meeting draws near the oil ministers from OPEC countries have got to be scratching their heads trying to come up with a new and novel way to say the same thing only spin it differently. The "market is well supplied" sound bite is growing old.

Analysts from every corner of the globe are writing commentaries about the need for OPEC to boost production or face a world economy that falls back into recession. The IEA said last week, "As global demand for oil increases seasonally from May to August, there is a clear, urgent need for additional supplies on a more competitive basis to be made available to refiners to prevent a further tightening of the market. The governing board urges action from producers that will help avoid the negative global economic consequences, which a further tightening of supplies would cause."

The IEA went on to imply a threat to OPEC saying, "IEA governors, in an effort to exert pressure on producers, said they were prepared to consider using all tools that are at the disposal of IEA member countries to stabilize the market." They were referring to the 1.6 billion barrels of oil held in strategic reserves by IEA countries that could be released to lower prices. That would be an interesting development to see IEA countries flooding the market during the high demand season to take away the trump card from OPEC. They could rebuild those reserves in the fall when demand declines BUT it would cost them a lot more to repurchase the oil. Some of these reserves have been held for a decade or longer and the cost per barrel is less than $20. Replacing those barrels in the fall would likely cost them $100 per barrel. Of course they would also receive a high dollar for sales they make today so it would likely be a break even.

OPEC released their latest oil outlook saying demand in China was increasing but the worries over the slowing U.S. recovery and the recovery effort in Japan would impose a downside risk for demand the rest of the year. They still put the expected demand growth for 2011 at +1.4 million barrels per day, a +20,000 bpd upward revision from the prior forecast.

At the coming OPEC meeting there could be a clash between Saudi Arabia and Iran. They are constant rivals in the region and in the oil markets. Iran's president Mahmoud Ahmadinejad fired his oil minister a couple weeks ago and said he would assume the position. Since Iran currently holds the presidency of OPEC, a rotating position where it moves from country to country every year, that makes the Iranian oil minister, now Ahmadinejad, the president of OPEC. Just what we need is to have a lunatic hothead egomaniac as head of OPEC. He will deliver the opening speech at the conference. This suggests there could be some really interesting conflicts develop since Saudi Arabia is the largest producer and the unofficial leader of OPEC. Whatever Saudi wants to do is normally what OPEC ends up doing. Analysts worry that Ahmadinejad will attempt to incite conflict at the conference in an effort to show supremacy over Saudi and the other Middle East nations.

Analysts believe having Ahmadinejad as president at the June 8th meeting in Vienna severely limits the chances of a major production increase. Iran and Venezuela are the two biggest hawks in OPEC. Neither can produce up to their actual quotas so they want everyone else to limit production as well to drive up prices. Ahmadinejad would like to see the price as high as possible to damage the USA, as would Chavez from Venezuela.

Recently the Associated Press reported the U.S. and Saudi Arabia were "quietly expanding defense ties on a vast scale" led by a little known project to develop an elite force to protect the kingdom's oil riches and future nuclear sites. The U.S. and Saudi are also in discussions to create an air and missile defense system with far greater capability to protect Saudi from against Iran. Saudi is buying $60 billion in aircraft and systems including U.S. built F-15 combat aircraft to insure superiority over Iran for years to come.

To say the outcome of the meeting is unknown would be an understatement. OPEC knows it needs to raise production at least temporarily to cover the summer surge in demand. They also know most of the world blames them for the high fuel prices. They would rather not be the target of universal scorn but they have to keep prices high to pay for all the social programs they have promised to keep their populations from rioting.

Since they are currently producing 2.5 mbpd over their quotas it would be easy for them to announce an increase in quotas of 2.5 mbpd and appear to the idiot press like they were caring and conscientious when all they are really doing is raising the quota to what they are already producing. It is all about the sound bites and press headlines and has nothing to do with reality. If they raised the quota to what they are already producing they could then increase their cheating to cover the summer demand spike.

Oil prices are likely to remain subdued until the meeting. There is little future in loading up on crude futures in anticipation of OPEC doing nothing. I think they are past that point even though it may be a battle to get any formal quota increase. There will be plenty of time to react to the events rather than try to anticipate them. Demand will rise even if production does not and that is our ace in the hole for long-term investments.

Jim Brown

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