Summary
In spite of continued production cuts, OPEC has failed to stem the fall in prices over the last few months. As the world economy slows down, demand continues to fall and OPEC is playing catch up to balance supply with lower demand. OPEC needs to cut another 2 million barrels per day of production at its December 17 meeting in conjunction with a Russian cut of 300 to 500,000 barrels per day to stabilize prices.
Analysis
Since Indonesia is leaving OPEC at the end of December and Iraq has no OPEC quota, the numbers in this discussion refer to the remaining 11 members or OPEC-11.
Going back to August 2008 as oil prices began their retreat from over $140 per barrel, OPEC-11 was producing 29.5 million barrels per day or nearly 700,000 over the quota of 28.8. OPEC-11 did not change this quota at their September meeting, asking for greater compliance. In October, the quota was reduced by 1.5 million barrels per day to 27.3. After taking no action at the November meeting in Cairo, oil prices continued to fall into the $40 to $50 range forcing OPEC-11 hand to act next week on December 17. Russia has announced that it will offer some proposals by that date.
With inventories rising in the USA and around the OECD to nearly 57 days of cover, OPEC will announce a production cut. Where the price goes will depend on compliance figures issued in 2009. Monitoring oil tanker fixtures are a much quicker way to get compliance information
A cut of 2 million barrels puts the quota just over 25 million barrels per day, a figure equivalent to the OPEC quota of June 2003 with one great exception. Angola was not a member of OPEC at that time and currently has a 1.9 million barrel per day allotment. That means the OPEC -10 must do with less production today, i.e. 23 million, than they did in June of 2003 when crude oil was trading around $30.
Meanwhile Russia, who is currently producing around 9.5 million barrels per day could indeed reduce oil production. However the government would lose $26 per barrel in export duty revenue as oil exports decline. Russia could circumvent this "production cut" surreptitiously by increasing refinery runs and exporting products.
The crude oil and product markets are in contango to such a degree that it makes economic sense to store NYMEX crude oil, RBOB and heating oil for a year. Over 26 million barrels of oil tanker capacity has been booked for storage while nearly every available storage tank at the NYMEX delivery points in Cushing for crude and New York for products has been taken. This implies further inventory builds ahead perhaps pressuring the contango and prices over the next few months.
The producers have the demand fundamentals working against them. An announcement of a 1 million barrel per day cut will be interpreted as not enough and I would expect the market to drop rather quickly to $35. A 3 million barrel per day cut by OPEC-11 alone will be deemed as unrealistic, an unachievable target and perhaps even a panicked reaction.
That leaves a combination of an OPEC and Russia production cut. This author thinks that is a 2 million barrel per day OPEC-11 cut in conjunction with another 300 to 500,000 from Russia. In that case, I expect prices to rise to $50-$55.
