OPEC has its work cut out to stop the oil price from sinking further
ENERGY analysts spent the first half of the year debating how expensive oil could get. Now they are asking the opposite question. On December 2nd the price of a barrel slipped below $47, the lowest level since May 2005 and less than a third of the peak reached in July.
The main reason for the slump is the darkening outlook for the world economy. Demand for oil continues to grow in a few spots, such as China. But in most places it is falling. America’s appetite for oil, for example, had been more or less stagnant for the past few years, but has recently dropped dramatically (see chart). Many now expect global oil demand to fall next year, and perhaps even this year—which would be the first decline since 1993. Meanwhile, several new oilfields and refineries, which were set in motion when the price seemed likely only to rise, are due to start up in the coming months, increasing supply just as demand atrophies.
The Organisation of the Petroleum Exporting Countries (OPEC) does not seem able to cut its production fast enough to keep pace with all this grim news. In October the cartel agreed to pump 1.5m fewer barrels each day from November 1st, reducing global supply by about 2%. But that cut is only just beginning to take effect, since it can take more than a month for tankers to reach their destinations. Moreover, OPEC’s members do not yet seem to be complying fully with their diminished quotas.
The king of Saudi Arabia recently said that $75 a barrel would be a fair price—an idea that other members of the cartel have echoed with enthusiasm. Oil’s plunge has left many of them in dire fiscal straits. This suggests that when the group meets again on December 17th, it will resolve to cut its production further. But Saudi Arabia will not want to bear all the cost, so it will insist that other big producers, such as Iran and Venezuela, should not only agree to further cuts of their own but also implement them.
Michael Lewis of Deutsche Bank argues that OPEC’s past efforts to prop up prices have succeeded more often than not. Since 1993, cuts in production have led to higher prices on three-quarters of occasions. The exceptions, however, have occurred when the world economy has slowed unexpectedly—most notably in 1998, after the Asian crisis, and in 2001, after the dotcom bubble burst. On those occasions, the price kept falling for more than six months after OPEC first began reducing its output. In 2001, for example, the cartel had to resort to a series of cuts, totalling 5m barrels, before the price finally began to recover.
If events take a similar turn this time, Mr Lewis reckons, OPEC will have to keep cutting its output for another year. The price may not hit rock bottom until early 2010. But the world economy looks less healthy now than it did in 2001, so OPEC may face even more of a struggle this time, he thinks. Deutsche Bank, for one, sees prices falling as low as $35 at times between now and then. After adjusting for inflation, Mr Lewis points out, that would only take the price back to its average level since 1972.
Dec 4th 2008
From The Economist print edition