OPEC to Cut Oil Supply as Crude Falls

Officially, the Organization of Petroleum Exporting Countries has a target range for crude oil of $22-$28 per barrel. With crude prices still the high side of $40 per barrel, one would think that supply is still inadequate. OPEC, it seems, is having second thoughts about its target. It has decided to cut supply by 1 million barrels per day to bring production back to its official ceiling of 27 million barrels a day. Having found a new ceiling, OPEC now wants to raise the floor.

OPEC knows that oil is much like the proverbial golden egg laying goose. If prices go too high, the developed world’s economy goes into a tailspin, and oil is hard to sell. Because of the inertia of a large machine like the global economy has, it is better to find a happy medium and keep it there so that producers make money and consumers keep consuming. Hence, it has its target range.

Interestingly, OPEC’s basic commodity is priced in US dollars, and has been for decades. With the dollar plummeting against the European currencies, and Europe is where many oil states like to spend their revenues, the producers are taking a substantial currency hit. Iran’s oil minister, Bijan Namdar Zengeneh, told the Financial Times “ . . . we lose more than 30 per cent of our revenue by the dollar depreciation.” For whatever reason, OPEC has chosen not to change the way it prices oil, although the case for pricing it against a basket of currencies is powerful.

Instead, the oil producers have decided to revalue their oil relative to the dollar. A 30% foreign exchange loss, if the Iranian spokesman is correct, is not hard to swallow if the price goes up from $28 to $42 a barrel, a $50 increase. Simple arithmetic shows a 20% gain in the result.

What the recent price rise proved to OPEC was the relatively inelastic demand curve. Oil was still shipping at $50 a barrel, and while there was some complaining, western economies continued to grow, and China’s (whose consumption exploded of late) positively boomed. In other words, the acceptable range for consumers looks higher than the official target range.

OPEC, though, isn’t behaving foolishly. The million barrel a day cut won’t take place until New Year’s Day, and that means it won’t hit consumers until February, when the northern hemisphere starts warming up but before everyone starts driving more than necessary. And OPEC will meet again at the end of January to consider cutting the production quota to 26 million barrels a day. They may not have to do that, though. Prices just might hold on terror fears, in which case, they may be able to move the target range above $30 a barrel without a production cut. Why leave money on the table?

© Copyright 2004 by The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without written consent.

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