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Thursday, June 16, 2011

OPEC Fraying?

The Organization of Petroleum Exporting Countries, OPEC, had one it most tumultuous gatherings in recent times on Wednesday, June 8. The question is: What does it mean for OPEC's future and oil prices?

OPEC was created in 1960, and its current members - Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela - form a cartel that produces roughly a third of the world's oil supplies on a daily basis.

OPEC seeks to influence global oil prices by setting production quotas for each member nation. As most economists will note, cartels rarely remain firm in meeting their goals because there always exists the incentive to boost profits be cheating. And over the years, that certainly has been the case with OPEC.

But heading into the June 8 meeting, few observers expected divisions within OPEC to deepen so significantly, and glaringly so for the entire world to see.

The top two OPEC producers were pushing in different directions heading into the gathering. Saudi Arabia was looking to boost production - by 1.5 million barrels per day - as the Saudis expect oil markets to tighten later this year, while Iran saw current supplies as adequate and likes the price of oil in the neighborhood of $100 a barrel.

Coming out of the meeting, Saudi Arabia, along with Kuwait, Qatar, and the United Arab Emirates, lost out in their bid to raise production, with Iran, Algeria, Angola, Venezuela, Ecuador and Libya achieving success in leaving production quotas unchanged.

As widely reported, the Saudi oil minister declared that this was "one of the worst meetings we ever had."

The immediate reaction in markets was to push oil prices up. But beyond the knee-jerk reaction, there is reason to be hopeful coming out of this OPEC fraying. Iran's victory could prove hollow.

First, anytime a government cartel shows signs of cracking or fraying, that's good news for consumers of the product, in this case, oil. Producing nations will have an added incentive to ignore quotas when supplying markets, and thereby exert pressures to lower the price.

Second, the nations looking to expand production are those most able to do so, especially Saudi Arabia, which reportedly has spare capacity of 3.5 million to 4.5 million barrels per day. And in fact, the Saudis pledged to expand production, and as The Wall Street Journal reported on Friday (June 10), "Oil refiners in Asia said Friday that Saudi Arabia, the world's largest crude exporter, is offering more crude to buyers for July."

Third, the split between Saudi Arabia and Iran stems in part from the recent uprisings in that region of the world. While those protests added a "fear" premium to the price of oil, this is one consequence whereby the effect could be positive in terms of working in the other direction on oil prices.

Is OPEC going away anytime soon? Of course not. But deeper divisions within the group will further weaken its influence, and that's a bit of welcome good news on the oil price front.

For good measure, if the Saudi assumption that oil demand will accelerate later this year due to a pick up in economic growth does not pan out, that will place additional downward pressure on oil prices.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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