Does the oil market listen to OPEC anymore?
In 2009, the world consumes about 87 million bbls of oil each day, of which OPEC contributes almost 30 millions. Being the largest and only cartel that has spare oil capacity, the markets often hears out OPEC for price signals and production quotas.
For the past few years or so, it appears OPEC signals have ‘waned’. Presumably no country in OPEC adheres to their production quota, choosing instead to maximise production, with only biggest producer Saudi Arabia holding some spare capacity at estimated ~1-2 million bbls. The fast growth of the global oil demand outpaced global supply. It was only after the global recession of 08/09 that spare capacity returned to a healthier 4-5 million barrels, boosting inventory in OECD countries to 61 days of cover, the highest level since 1998.
OPEC meets once a month, where a ”call on OPEC’ had been determined since 1973. This call on OPEC is the oil production OPEC needs to produce to make up for the difference in global oil demand and non-OPEC supply. Over the past few years, this “call on OPEC” has not changed much. This is as most of the recent increase in the oil demand especially from China and the developing countries has been met mainly by Russia and the former Soviet republics. Notwithstanding its ‘normal’ capacity production and dwindling share of world oil demand, do the markets even listen to OPEC moves anymore?
The author is of the opinion that OPEC has a more long term influence than a short term influence on the markets. In other words, the back end of the forward curve takes its cue more so than the short end of the forward curve. A plausible explanation for this is due to the volatility of the short end caused by supply outages and seasonal oil demand. This negates the market influence of OPEC production hikes or cuts. Another reason is logistical as it takes almost 2-3 months for oil from the well heads in the main Arabian gulf production areas to reach the main markets in the developed markets. An interesting article in the Energy tribune and the conclusion reached by IEA or the EIA is the continued dependence on OPEC oil production into the next two decades.
The world needs OPEC oil for its economic growth and standard of living even more so in the future. OPEC is ‘needed’ to meet the expected growth in demand even as supply dwindles in the non OPEC countries.
The longstanding ‘interaction cues’ from OPEC and the market have also led to prices equilibrate faster. It is almost a case of ‘after all these years I know what you will do next.’. OPEC determines its production quotas from the oil prices or inventory. It is an almost open secret that OPEC will not cut production when prices are high but not too high, so as not to disrupt economic growth and speed up the usage of alternative fuels. In Mr Ali al-Naimi, the Saudi oil minister’s words, “Good demand, reliable supply and beautiful prices”
It will cut production when prices drop too low, as in the recent case in 2008 when prices dip to $30, to maximise its overall revenue. Prices equilibrate to $40 after that for most of the recession, as the markets put a floor on prices. Such range bound prices are what OPEC seek to achieve. Under this presumption, the oil price spike to $150 in Jun 2008 can be understood. OPEC can just do no more as it has zero spare capacity, causing prices to break out of its ‘normal’.