Sweet and Sour: High oil prices may derail Opec policy

A few years ago while on a visit to Italy, I boarded a train for Rome from an Adriatic resort. I found a seat and settled down with my magazines waiting for the train to move, which it did after a short but unsurprising delay.

After all this is Italy. I was so engrossed in my reading matter I didn't notice that after a while, we had stopped moving. Only too late did I realise that I had actually been sitting in the wrong end of the train and the front carriages had already moved on to Rome, leaving me stranded somewhere en route.

A few days ago, a veteran journalist and expert in oil policy wrote an editorial in an Arabic language newspaper asserting that after years of drift, Opec was now firmly in the driver's seat in the way it is managing oil markets.

True, but like my train to Rome, the 11 members in the Arab-dominated producer group are driving only part of the train. Given recent oil prices, which are at their highest in nearly 14 years, one would be tempted to say that Opec is driving a gravy train through roller-coaster markets but that would imply no effort on the part of its members and that would not be fair.

Production policy

However, to say that Opec is in full control would imply that the only influence on the price of crude oil these days is Opec's production policy. Opec cannot take full blame. The producer group has argued that it has set its recent output ceiling with a view to defending its $22-$28 per barrel price target.

But you don't have to be terribly numerate to see that with prices for US oil futures closer to $40 per barrel, that policy does not make much sense. So why has Opec not scrapped its price band and adopted a more realistic one?

Because, says a senior delegate, there is a premium of at least $10 per barrel over which Opec has no control. Take that away and you are closer to the Opec band than just mere numbers suggest.

First there is the Iraq war premium which is still there. As the US occupation enters a second year, Iraqi oil exports are not yet running as smoothly as the interim government had hoped and so cannot be taken for granted even though they have reached pre-war levels.

Venezuela's uncomfortable relationship with the US as President Hugo Chavez clings to power, Nigeria's labour problems and Iran's stand-off with the West over its nuclear programme also account for a few dollars of that premium.

Reports by a couple of US-based experts suggesting Saudi Arabia may have inflated the true state of its crude oil reserves has also helped to inflate oil prices by casting doubts over the ability of the world's powerhouse to meet any sudden shortage of supply by raising its production level to a higher, sustainable level.

In addition to endemic problems within the oil-producing nations, external factors have also conspired to keep oil prices sizzling in recent weeks, hitting their highest level since the Iraqi invasion of Kuwait in 1990 after the deadly train explosions in Madrid.

The Arab-Israeli conflict provides a perennial premium that is factored into the oil price even in peace time and last week's murder of Sheikh Ahmed Yassin by Israeli forces was a grim reminder that the Middle East, home to 65 per cent of the world's crude oil reserves, remains a volatile region where peace remains elusive.

After this, it seems trite to talk about the dollar's weakness, tight gasoline stocks in the United States and the fact that speculators are holding on to large positions in oil markets as other reasons for the unseasonable firmness in oil prices as we approach the lower demand second quarter but these are unavoidable facts.

Furthermore, the US continues to buy crude oil at high prices to fill up its strategic reserves despite calls to defer such deliveries until prices ease.

The situation has reached a point where both the West's energy watchdog, the International Energy Agency (IEA), and the US Energy Department have expressed concern about high oil prices coupled with low stocks.

IEA Executive Director Claude Mandil argues that Opec does have a role to play in cooling prices. By maintaining an output policy that keeps supply tight, the oil producers are guaranteeing volatility in oil markets and encouraging speculators to play the market.

Stabilize the market and the speculators will take their funds elsewhere, he suggests. The US energy secretary, Spencer Abraham, has indicated that he will break his own rules of non-interference and speak to Opec about its production policy ahead of the next Opec meeting in Vienna today.

What is strange in this market though is that Opec has actually not implemented any of the production cuts that it agreed to this year. All we have had has been an agreement to trim unofficial leakage and a pledge to reduce the official ceiling from April 1.

Indications from buyers of crude oil from Opec states so far indicate that there has been only a paper cut and no significant volumes of actual oil have been drained from the markets. This would strengthen the argument that it is indeed psychological factors that are influencing the price more than an imbalance of supply and demand.

Furthermore, much of the crude oil supplied by Opec's Arab producers is heavy, sour crude oil rather than sweet, light crude oil, which my Opec expert says is not what the market, and in particular the US market, needs.

Even if Opec were to open the taps, it would not find too many takers for its sour grades. US refineries would be using as much light crude oil as they can at this stage in the run-up to the driving season to stock up on light ends like gasoline, more so since stocks of the produce are currently low.

Solution

Whatever the causes though, just by its very existence and its role in managing markets, the world will be looking to Opec for a solution to high prices and ministers preparing to travel to Vienna will have a tough task ahead of them.

Do they rescind an agreement already adopted in February to cut their production by a million barrels a day at a cost to their credibility and risk prices going into freefall or do they stay on track and risk losing market share for the sake of maximizing their revenues?

One minister has suggested that it is too late for Opec to change tack and that it should implement the agreed cuts in two stages. I wonder if he too was on that train to Rome?

Kate Dourian is Middle East editor of Platts, the energy information division of the McGraw-Hill Companies. The opinions expressed in this column reflect the author's and not those of Platts