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The Economy: OPEC's Cut Aims to Prop Up Prices

Source: www.gulfoilandgas.com 12/15/2006, Location: Africa

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OPEC, in announcing it plans to slice its output by an additional 1.9% starting Feb. 1, is sending a strong signal that it will try to prevent oil prices from sliding further. The real impact of the cartel's latest output move on oil markets remains unclear. The big unknown is whether members of the Organization of Petroleum Exporting Countries will actually implement the decision, which calls for a collective cut of 500,000 barrels a day. Some OPEC officials say that will depend on demand in the next two months, the level of prices and the amount of oil held in inventories in major consumer countries.

But the announcement signals OPEC's intention to keep oil supply tight to shore up prices and trim global oil inventories, whose buildup this year was threatening the cartel's power. OPEC's move comes even as prices have stabilized in the wake of a much larger 4% cut in October. A week ago, OPEC had been leaning against a second cut. But in recent days, a chorus of fears arose about a possible softening of oil demand early next year.

Crude prices swooned to $56 a barrel in November after peaking at a nominal high of $77.03 July 14. Oil prices rose yesterday, with light, sweet crude for January delivery up $1.14, or 1.9%, to $62.51 a barrel on the New York Mercantile Exchange. January Brent on London's ICE futures exchange rose 79 cents to $62.12 a barrel.

One factor making it difficult to parse the impact of yesterday's decision is that, so far, OPEC members haven't fully complied with the prior round of reductions. That move called for an output cut of 1.2 million barrels a day, or about 4%, to 26.3 million barrels a day, effective Nov. 1. Independent estimates of OPEC's compliance generally put the actual reductions at about 600,000 barrels a day. Saudi oil minister Ali Naimi, the effective leader of OPEC, said yesterday that compliance was nearly 80%, meaning that supply had been cut by almost one million barrels a day.

Even modest compliance with the new cut could spell pain for oil consumers, however. In February 2004, OPEC announced production cuts just as world oil demand began soaring. OPEC reversed course and began pumping flat-out to sate demand instead, but prices jumped anyway.

In a brief interview after yesterday's meeting, Mr. Naimi said OPEC won't deny the market extra barrels of oil if they are really needed. "What did we do before?" he asked rhetorically, alluding to the move to ramp up output in 2004 after the aborted cut. "People don't know the trouble we go to, to balance the market," Mr. Naimi said. "Without us, the oil market would be chaotic."

A senior OPEC official said the cut was a pre-emptive measure meant to ensure the cartel has a mechanism in place to reduce supply immediately if needed. But if buyers demand more oil than the cartel is forecasting, he said, OPEC will deliver it. "We need an agreement to cut [supply]," this official said. "We don't need an agreement to supply more oil if customers really want it."

Indeed, some analysts view yesterday's decision as an insurance policy to be used should prices weaken next year, when some estimates show that the rise in output from non-OPEC producers will exceed anticipated growth in world demand for petroleum.

"This is an option on a second cut," said Roger Diwan, an analyst at PFC Energy in Washington "They want to signal an aggressive oil-market-management strategy, but the decision also allows them to retract it if the market overtightens," Mr. Diwan said.

The entry of Angola on Jan. 1 should strengthen the cartel by bringing into OPEC's fold a country whose oil output is soaring. OPEC accepted Angola as its 12th member -- the first entrant since 1973. Angola estimates that its production will rise to about two million barrels a day by the second half of 2007 from about 1.4 million barrels a day currently.

ngola won't participate in the February cuts. But Qatar's oil minister, Abdullah bin Hamad Al Attiyah, said Angola would be party to OPEC's output decisions from March onward.

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