Supply, demand, liquidity and history. Those are the factors that Organization of the Petroleum Exporting Countries (Opec) oil ministers will have to consider during next week’s meeting in Abu Dhabi.
Taken together, they suggest that the oil producers’ cartel would be badly served by giving in to political pressure for a 2% increase in the daily production quota of 28 million barrels.
Opec has done what it said it would at its 11 September meeting—increased production by 4%. But the additional supply doesn’t seem to have done much.
In a counter-seasonal rally, the price of crude rose from around $75 (Rs2,985) to the current $92. It has flirted with $100 twice in the last month.
Pressure from higher demand doesn’t explain the price rise. On the contrary, high prices are doing what theory says they should—dissuading customers. Demand growth expectations for the short-and long-term have been revised downward, as even fast growing China finds greater rewards from energy efficiency. Current crude inventories are more than ample.
Liquidity is the force that keeps the oil price high in the face of near-record levels of supply. Not that oil has fully escaped the tighter financial conditions, which are undermining so many markets. Before popping up on Thursday morning after an explosion in a US terminal, the price of crude had fallen 10% from its peak. That’s less than the 20% drop in copper prices. But the low margins needed for oil trading have kept speculators in the game, and the price high.
Opec runs the risk of repeating history. When Opec poured oil on the market in 1997 and 1998, the price fell from $27 to $10 a barrel. It took several years for the world to mop up all the extra supply.
To get prices back up then, Saudi Arabia had to cut production by nearly 50% of what it is pumping currently. The sharp drop in revenues spawned talk of Saudi political instability.
A decade later, the economies of most Opec members remain heavily dependent on oil. For them, too much supply could prove very costly.
Opec oil ministers are expected to meet in Abu Dhabi on 5 December to discuss production levels.