OPEC's raising output

Myra Saefong's Commodities Corner
OPEC's raising output, but oil prices rally anyway
By Myra P. Saefong, MarketWatch
Sep 11, 2007

It's a bit of a mystery why crude futures closed at a record level Tuesday, even after some of the world's biggest oil producers agreed to a hefty increase in oil output levels.

At a meeting in Vienna on Tuesday, the Organization of the Petroleum Exporting Countries agreed to raise its production level by 500,000 barrels per day, effective Nov. 1.

It wasn't clear, at first, from which production level the increase would be made from.

OPEC's official output quota for 10 of its 12 members was at 25.8 million barrels per day, but the U.S. Energy Department said OPEC's actual output in July, excluding Angola and Iraq, was at 26.7 million barrels per day.

Then news reports emerged with the new official OPEC quota of 27.2 million barrels -- which implies that the cartel is recognizing that it's been producing above its target.

OPEC "'formalized' ... their current overproduction, which was roughly 900,000 barrels per day. Then on top of that, they added 500,000 barrels per day in new production," said Kevin Saville, a managing editor at Platts, who is on site at the meeting in Vienna.

"So, on its face, this wasn't just an empty gesture from OPEC," he said. "It is saying it will add 500,000 barrels per day of new oil on the market from Nov. 1."

But exactly how much of that 500,000 barrels per day will actually hit the market remains to be seen," said Saville.

Carefully worded

Obviously, OPEC raised production because members fear a slowing in the economy and they're trying to keep prices down, said Phil Flynn, a senior analyst at Alaron Trading.

But if the Fed cuts interest rates and the economy isn't slowing as much as people think, then energy demand will remain strong and the market will need more supply, he said.

Given that, the oil market probably rallied because the economy may be stronger than was originally thought, "taking away the thunder from the OPEC increase," he said.

It's all "fuzzy math," on the part of OPEC, he said. It all "comes down to what OPEC thinks their production is, versus what it actually is." And "they're admitting that they're overproducing."

The closing speech Tuesday from Mohamed al-Hamli, president of the OPEC conference and energy minister of the United Arab Emirates, seemed to be carefully worded.

"The conference decided to increase the volume of crude supplied to the market by OPEC member countries, excluding Angola and Iraq, by 500,000 barrels per day," he said.

So traders are realizing that it's not just a "paper increase," said Flynn.

Indeed, based on the news reports, "the move set for Nov. 1 is no longer a symbolic one, but an actual agreement to increase current production figures," said Neal Ryan, a manager and market analyst at Ryan Oil & Gas Partners.

"That being said, it's probably already been priced into the market at this point, as most were hoping to see a number closer to 1 million vs. 500,000," he said in emailed comments.

Difficult decision

Still, it wasn't any easy decision to make in the first place.

"OPEC was between the proverbial rock and a hard place," said James Williams, an economist at WTRG Economics. "U.S. petroleum stocks have been falling. Demand increases in the fourth quarter and without an increase, a shortfall was possible late in the year."

Williams points out that the timing of the increase for November matches the beginning of the peak demand season.

And "by increasing production, OPEC can avoid some of the blame for a recession if it comes," he said.

But at the same time, Williams warned that the market should expect the actual production increase to exceed 500,000 barrels per day.

"While high oil prices are often blamed for causing recessions, recessions usually cause a drop in oil prices and pose the greatest downside risk to price," he said.

Then again, maybe it's all about OPEC "feeling the 'subprime crunch,'" said Anthony Sabino, a professor of law at St. John's University whose legal practice includes oil and gas law.

"Clearly, the oil-exporting nations, who so desperately depend upon 'petro' dollars, euros, and yen, sense that the tightening of credit will cool off the economy and slacken demand," he said in emailed comments.

As such, "the per-barrel price of crude is too high to sustain current sales and inflows of dollars from the oil consuming nations," Sabino said.

By opening the taps wider, OPEC "seeks to drop prices in order to stay marketability in a jittery economic climate," he said.

Meaningless move?

In the end, the decision could just be a meaningless move.

OPEC's quota decision likely means nothing, said Charles Perry, chairman of energy-consulting firm Perry Management.

"Other than the Saudis, the rest of OPEC sort of set their own quotas," he said. "But most are near capacity, so they do not have room to go any higher."

"The real story in all of this is the world is at or near maximum capacity, and will be until a lot of additional production is developed," said Perry.

If OPEC's talking about a target of 27.2 million, then it's already close to its capacity, excluding the Saudis, he said. "Just about everyone is skeptical of OPEC increasing their production very much" with members near their peak production.