OPEC Politics Prevents Consensus

Jim Brown
Printer Friendly Version

Political infighting between the twelve OPEC countries kept delegates from reaching a consensus and raising production quotas as many had expected. Any quota raise would have been only symbolic in nature and have no direct impact on production but the lack of a hike is telling the world OPEC either can't or won't make any effort to reduce prices.

The OPEC meeting was the worst in 16 years according to the Saudi Arabian oil minister Ali al-Naimi. Normally we each present our case, discuss the numbers, argue over the conclusions but then reach a consensus and act accordingly. The meeting this time was a war over political ideologies and recent events in the MENA countries.

Saudi Arabia, Kuwait, Qatar and the UAE wanted to raise quotas by 1.5 million barrels per day as recommended by the OPEC committee that met earlier in the week. The remaining nine countries led by Iran, Iraq and Venezuela were adamant against increasing production claiming the market is well supplied.

What it really boiled down to was hostility against each other for the handling of the various factions and governments in the current series of uprisings in the Middle East and Northern Africa (MENA). The Iranians, currently holding the rotating presidency of OPEC, were openly hostile against Saudi Arabia for providing military support to Bahrain to crush the Shiite uprising there. Iran is also exceedingly hostile against the U.S. because of the pain inflicted by the nuclear sanctions, which includes the buying and selling of petroleum products. If Iran could push prices to $150 a barrel in order to hurt the U.S., otherwise known as the great satan, they would do so in a heartbeat. Add in Venezuela, Ecuador and Libya and the price hawks won the day.

The failure to at least raise the official quota levels to legitimize the level of current production is a serious slam to the developed nations. While raising the quotas by 1.5 mbpd would have simply put them in line with current production it would have sent a signal that OPEC was at least concerned with appearances and the current pain at the pump. By not simply legitimizing the current production they are basically flipping the world the bird and saying we don't care if fuel prices are high. Tough it out because it is our oil and we want top dollar. This is setting a dangerous precedent for the future. If OPEC can flaunt their power at $115 Brent then it will embolden them to shoot for ever higher prices later.

On the flip side Saudi, Kuwait and the UAE said they would produce in excess of the quotas and produce an additional 1.5 mbpd as needed. Since they are basically the only OPEC countries with excess capacity they would have been the beneficiaries of any raised quotas anyway.

That is another problem with the eight countries that forced the quotas to remain the same. It would do them no good to raise the quota because they already can't produce enough to meet their current quota in most cases. Iran, Libya and Venezuela have not met their quotas in years. If they agree to a quota rise then other countries will get to pump more, which lowers the price of oil and costs the underperformers money. If Venezuela can only produce 2.0 mbpd and their quota is 2.5 mbpd then the quota is irrelevant. They will produce 2.0 mbpd whether the price is $75 or $150. The only difference is how much money they get every month. In reality would you vote to let somebody else produce more oil if it was going to lower your income by $25 a barrel?

Several analysts were quick to point out that the politics would have been ignored if the countries voting against the increase had the capability to produce more. Everyone would always vote to raise their own quotas if they had the capability to produce at a higher rate. This suggests, as many have expected, that OPEC spare capacity is far less than they claim.

That theory is no stranger to these pages. If Saudi, Kuwait and the UAE are the only ones with any material capacity then it will be up to them to produce it on their own in violation of the quotas. However, there is always the problem of oil grade. They may have excess capacity that they can boast in the press on a weekly basis but if it is not light sweet crude then all the capacity in the world won't do prices any good.

Since the Saudi oil minister said in a prominent interview immediately after the meeting that Saudi, Kuwait and UAE would immediately begin producing whatever was needed regardless of the quota it really means "the quota system is dead." You may remember back in the late 1990s when Saudi was having trouble with some OPEC cousins and decided to teach them a lesson. Saudi opened the valves and flooded the market with oil and knocked prices to just over $10 a barrel. That bankrupted the budgets of several OPEC nations and Saudi regained control over the flock.

Obviously Saudi can't do that today because the difference between actual demand and production capacity is not that great. Even if Saudi decided to pump an extra million barrels per day from now on it probably would not have a seriously detrimental impact on prices. We might see $85 again next spring but demand is growing so quickly around the world that by spring that million barrels would be absorbed.

A JPM analyst said this time last year there were 2.0 mbpd of excess production in the market. Today he claims there is a shortfall of 100,000 bpd. By the end of Q3 he expects that shortfall to rise to 1.5 mbpd. The OPEC commission assigned to study demand and production and report back to the delegates said there would be a shortfall of 1.5 mbpd later this year. The IEA is also claiming there will be a major shortfall by year-end and continue into 2012. The U.S. government is predicting a serious shortfall in 2012. This suggests the big headlines over the OPEC meeting are much ado about nothing. As prices rise, production will rise because greed is still the number one motivator for OPEC nations.

Remember, any quota hike this week would only have been a symbolic gesture to legitimize existing production. Iran and Venezuela had nothing to gain politically from allowing that to happen and they could have faced a decline in prices.

The long-term impact of this event is simply a better understanding that OPEC is now longer concerned with maintaining an orderly oil market because they are reaching the point where they can no longer produce any additional oil. If you can't change the future why pretend you can?

Jim Brown

This newsletter is only one of the newsletters produced by OilSlick each day. The investment newsletter is also produced daily and contains the current play recommendations in the energy sector. Stocks, options and futures are featured. If you are not receiving the "Play Newsletter" please visit the subscribe link below to register.

Subscribe to Energy Picks Newsletter

See a list of our closed plays from 2010 here: Closed Positions