ENERGY MATTERS: Can OPEC Steer Southbound Price Train?

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Wednesday, November 1 11:31 PM SGT

ENERGY MATTERS: Can OPEC Steer Southbound Price Train? By David Bird A Dow Jones Newswires Column

NEW YORK (Dow Jones)--After chasing the runaway train of rising crude oil prices on its dash uphill, will OPEC be better at putting on the brakes when prices head south?

If the group is committed to its current price-band mechanism, the answer, like a freight train echoing in tunnel, is a loud "No."

Here's why:

Under OPEC's price-band formula, if the price of the group's reference basket of crudes remains above the $28 upper-end of the $22-$28 price band for 20 trading days, OPEC will add 500,000 barrels a day to output quotas.

Such a move was put into effect on Tuesday, with the 20-day countdown restarted for the next potential quota increase.

OPEC President Ali Rodriguez signs on to Energy Matters' expectations that the price of OPEC's reference basket of crude won't drop back below $28 before the end of the first quarter 2001.

That means that unless OPEC derails the price-band plan championed by Rodriquez, the trigger for further rises will be tripped at the end of November, December, January and so on through the end of the first quarter.

That would wildly inflate OPEC's output ceiling to the point of absurdity and even push Saudi Arabia - the only country with significant spare output capacity - beyond its limits.

It's well known that the latest rise in quotas (which came after 55 days, not 20 days, of prices above the $28 level due to an OPEC quirk) is a ruse, which may not add any new barrels to the market, as many countries already are pushed to capacity.

If OPEC doesn't take steps to end the price-band charade at its Nov. 12 meeting in Vienna, the situation could truly get out of hand.

The most important decision ministers face in 12 days is to set the date for an emergency meeting - probably in February - to put in place a plan for real, deep output cuts, which would be backed up by the price formula, only if prices fall too sharply.

OPEC Pumps More Air, Not More Oil

All OPEC is doing by sticking only with the price-band system is pumping air - not oil - into the market.

Taken to extreme, if prices don't move back into the band before the end of the first quarter, a runaway price-band mechanism could give OPEC's 10 members an output ceiling of 29.2 million b/d by the end of the first quarter, exceeding estimates of the group's total production capacity of 28.3 million to 28.9 million b/d.

Member countries who don't have excess capacity are more than willing to play the quota-inflation game since they get a higher, phantom level from which to cut output.

When it comes time to slash production - either through the price-band mechanism or a negotiated deal - those countries will be cutting paper barrels, while the Saudis would be the only ones taking oil out of the market.

Under the price-band system formalized in June, ministers proved they were more concerned with runaway prices on the downside than on the upside.

The formula calls for OPEC to cut 500,000 b/d of output if the basket price falls below $22 for just 10 days, half of the upper-end threshold.

Some in OPEC say the group is "trapped" in the price-band mechanism already and will be in a worse position on the downside.

"This is what is wrong with the mechanism," says a senior OPEC source. OPEC is "running after the market" to halt gains now and will be doing the same when prices start to fall.

At some point, the strong market - held up largely by expected winter demand in the Northern Hemisphere and low heating oil stocks - will turn and OPEC's price-band system won't allow the group to get out of the way fast enough.

A Worry On Prices - 'Avalanches Happen'

"Avalanches do happen," says an OPEC delegate, recalling the price drop after Saudi Arabia pushed through a sharp output rise at OPEC's late 1997 meeting in Jakarta, which corresponded with an extremely warm winter and the Asian economic crisis.

The International Energy Agency forecasts that demand for oil from OPEC and stocks in the current quarter stands at 29.1 million b/d, but sees it dipping to 28 million b/d in the first quarter 2001.

With the second-quarter and the end of strong winter demand, the call on OPEC and stocks is projected to drop to 26.3 million b/d - about the level of OPEC's September production, excluding 2.9 million b/d from Iraq.

While anxieties are building over how to address inevitable low prices, some in the group are complacent and unconvinced prices will drop through the bottom of the band.

The scenario of prices plunging from around $30.50 now, to say $25 - down sharply but still within the band - will create new tensions in the group, as members are unwilling to fully surrender the huge windfall of current high prices.

It will put to the test OPEC's spoken commitment to keep prices within the $22-$28 band, and essentially not care where they sit within that range.

Some in OPEC note that world oil demand is projected to rise by as much as 1.9 million b/d in 2001, putting the call on OPEC and stocks at above 30 million b/d by this time next year. Concerns that the group will be pressed to pump at the required level then may temper the scope of cuts between now and next year.

For OPEC, the goal will be to take control and gently squeeze the brakes on the locomotive of lower prices - not just try to jump out of its way and chase it on its downhill rumble.

(David Bird is senior energy correspondent for Dow Jones Newswires.)

http://asia.biz.yahoo.com/news/asian_markets/article.html?s=asiafinance/news/001101/asian_markets/dowjones/ENERGY_MATTERS__Can_OPEC_Steer_Southbound_Price_Train_.html

-- Martin Thompson (mthom1927@aol.com), November 01, 2000


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