OPEC and Economics

Jim Brown
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The price of oil remain stuck in a narrow range centered around $100 for WTI and $115 for Brent despite several weeks of bad economic news that depressed the equity markets. Concern over this week's OPEC meeting also provided uncertainty about direction.

The weak dollar offset the weak jobs report on Friday to rescue oil prices from their lows to close back over $100. Crude has gravitated to this level for the last four weeks despite some serious volatility. Every economic report showing a decline in the statistics was offset by the falling dollar. Eventually this trend will reverse. However, with a light economic calendar this coming week the focus will be on the OPEC meeting.

The OPEC moths are flocking to the flame of the press microphones already and the meeting does not start until Wednesday. A "senior Gulf OPEC delegate" said on Friday that "OPEC is most likely going to increase production quotas because the groups senior advisory board recommended an output hike to meet an expected rise in demand." Also, "The amount of the increase is yet to be decided by the OPEC ministers. All the numbers in the market now are just guesswork." The Economic Commission Boardmet on Friday and they expect demand to rise in the second half of the year. They did not recommend a particular number of barrels to be produced.

Saudi Oil Minister Ali al-Maimi told reporters in Poland that OPEC was ready to raise crude oil output to meet any increased demand. "Based on lost Libyan output and increased demand in the second half of the year, more members now see the need for an output hike now."

OPEC has not changed its output quota since December 2008 when they slashed output as oil prices were crashing due to the recession. They cut output by 2.2 mbpd starting on Jan 1st 2009. When combined with the 2.0 mbpd cut from Sept 2008 that brought the total "stated" production cut to 4.2 mbpd. They never achieved 100% compliance with the 2008 quotas with about 50% the closest they achieved. Today they are producing about 2.5 million barrels per day more than the official quota so unless they raise the quotas by more than 2.5 mbpd the announcement will be strictly fodder for the press so they can claim they did something to reduce fuel prices. The majority of the global public never see past the headline so it will be a propaganda win for OPEC but may not be accompanied by any actual increase in production.

An announcement of that magnitude could still send prices lower simply because investors don't understand the actual mechanics of the quota and the process. We also don't know to what level the cheating will rise based on the new quotas. A raised quota could give them an opportunity to cheat at a higher level. Of course that assumes they actually have some excess capacity to cheat with.

Another OPEC delegate said he doubted OPEC would make a formal, concerted change and that individual members would likely increase output where possible to make up for rising demand.

He said this because of the current fragmentation of the OPEC cartel. Iran is adamant that prices are stable and production should not be increased. Iran holds the annual rotating OPEC presidency for 2011. However, Iran's oil minister was fired last month so there is no specific individual to act as the president at this meeting although an unnamed cabinet minister was slated to appear as the delegate from Iran. However, Iran announced on Friday that Mohammad Aliabadi had been named as the new oil minister. He is a close ally of President Mahmoud Ahmadinejad and the head of the parliament's energy committee said Aliabadi was "the worst possible choice" and would damage the country's vital energy sector. It is unknown if the new appointment will replace the unnamed cabinet minister at the OPEC meeting.

Venezuela is also very vocal about no additional production. Venezuela is currently involved with a sanction fight with the USA and would love to see prices move higher. They cannot produce their current quota of oil so having quotas raised across OPEC would not help Venezuela. Any decline in prices from such a move would hurt Venezuela.

Libya and Nigeria are having production problems and can't make quota. That really leaves Saudi Arabia and Kuwait to do the majority of heavy lifting if quotas are raised. Saudi is hostile at the USA for the Egyptian revolution and may not act in the best interest of the U.S. at this meeting. Also, after the aborted production increase when Libyan oil stopped flowing, there were signs they don't have any excess capacity that fits the parameters of what the market wants. They have heavy sour oil and the market wants light sweet for summer gasoline production.

OPEC production actually fell in April to 28.748 million barrels per day. Production increased in May by 355,000 bpd to 29.103 mbpd. That is total production from all 12 OPEC countries although Iraq does not have a quota. Saudi Arabia increased production by 450,000 bpd in May to 9.0 mbpd.

That may sound contrary to my earlier statements but none of that was exported. In the summer months demand for electricity for air conditioning spikes in Saudi and they use the extra oil to generate electricity. Saudi is growing at the rate of +6% GDP and they are racing to install several gas fired generation plants so they can make more oil available for export. GE is the biggest beneficiary in that regard. They have installed over 500 gas fired turbines in Saudi for electricity generation. Saudi electrical demand is expected to double over the next ten years and without the gas turbines that would have taken another 2.0 mbpd of oil off the market. Saudi currently burns between 0.8 to 1.5 mbpd for electricity.

Libya actually produced an average of 200,000 bpd in May. That was only a fraction of the normal 1.396 mbpd. How much of that oil actually made it to market is unknown.

In unrelated news Transcanada said it was restarting the Keystone pipeline on Sunday after being closed for a week due to a leak at a pumping station in Kansas. The pipeline transports 591,000 bpd from Canada to Cushing with stops in between. This news could weaken prices slightly on Monday.

Jim Brown

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