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Opec’s dilemma: sticky supply, slippery demand

Opec’s dilemma: sticky supply, slippery demand
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First Published: Tue, Dec 30 2008. 12 01 AM IST

Updated: Tue, Dec 30 2008. 12 01 AM IST
Saudi Arabia, the most influential member of the Organization of the Petroleum Exporting Countries (Opec), is targeting an oil price of $75 (Rs3,660) a barrel. It’s not likely to reach that goal in 2009.
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A year ago, oil was around $100. Some prognosticators expected the price to rise a lot, and some looked for a sharp fall. Both were right. The price per barrel first shot up to $147 and then fell back vertiginously to $40. It’s enough to make anyone give up the prediction game.
That game is particularly tough in oil because the price isn’t set simply by the traditional factors of supply and demand. Financial flows, including foreign exchange and availability of credit, play an important role. The supply dynamics seem to support a case for a higher price.
Opec, the oil cartel, says it will implement a record-busting 4.2 million barrels per day (mbpd) cut in the supply of oil—about 4% of the world’s total. If they follow through on their commitment, analysts believe it would lead to a shortage of about 1.7-2 mbpd in 2009. In theory, that would boost the price, perhaps close to $75 a barrel.
The problem is that few believe Opec will follow through on its cuts, although the cartel claims it has already cut 1.7mbpd of the initial 2 million it pledged in September. But cutting another 2.2 million on top of that is a tall order for strained Opec governments. On the demand side of the equation, the arrows point downward—to lower prices.
Difficult days: A file photo of a drilling rig.The global recession has already hit demand, especially in the US, which accounted for 80% of the overall fall in demand from the OECD countries in 2008. Vladimir Weiss / Bloomberg
The global recession has already hit demand, especially in the US. The US accounted for 80% of the overall fall in demand from the Organization for Economic Cooperation and Development countries in 2008, according to Barclays Capital. And oil thirst is likely to get weaker from here.
The more pessimistic the economic forecast, the lower the oil price. It could easily drop down to $30, but supply cuts will probably bring it above that level by year-end.
Then there are the financial factors. When money was easy, oil purchasers—both consumers and investors—had enough cash to push up the price. A weak dollar made oil especially attractive to buyers with other currencies.
But when the financial turmoil forced many hedge funds to make massive redemptions, they sold heavily, pushing the price down at a furious pace.
Credit conditions aren’t likely to get much easier in 2009. Even if banks start lending more, oil won’t be an early beneficiary. After the 2008 debacle, it will take some time before commodity funds come back into fashion.
With supply sticky, demand down and credit scarce, the Saudi $75 target looks out of reach for a while. But with governments creating money as if there were no tomorrow, there’s a risk that inflation will eventually come back in a big way.
Oil, a tangible asset, could look like a safe investment—and once more outperform.
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First Published: Tue, Dec 30 2008. 12 01 AM IST