Oil prices in the U.S. have dropped from an all-time high of more than $147 per barrel in July, down to around $40 per barrel this month. This price drop has given many a much needed break at the gas pump amid the financial crisis, yet it’s a break that is likely to not last much longer.
Major changes are in the works this week.
The Organization of the Petroleum Exporting Countries (OPEC) is holding a conference this week in Oran, Algeria from Dec. 16 to 17 to discuss their next move. At their last conference on Oct. 24, drops in oil prices were a major subject. Following the meeting, OPEC had announced that they would cut production of oil by 1.5 million barrels per day starting Nov. 1. The hope was that the production cut would create more demand and help prices to rise again.
Their last cut didn’t have the perceived effect and a larger cut in production is speculated to be enacted following this week’s conference. According to Walter Zimmermann, vice president of United Energy, a company which provides advisory services for the oil industry, a large production cut has been long overdue.
“They need to cut production because demand has fallen sharply. The question is can they cut production enough and even if they do cut production, the fact that they didn't cut production earlier has created a bit of oversupply on the market,” said Zimmermann in a phone interview.
Due to oil overproduction, many countries have full backup supplies of oil. The Strategic Petroleum Reserve in the U.S., the largest emergency fuel storage facility in the world, is almost at full capacity. Also, the financial crisis has caused a reduction in oil purchases. This has driven oil prices down to a level that is placing some oil exporters in a difficult spot.
“It's probably the worst environment for OPEC since they were founded,” said Zimmerman. “They've had to deal with temporary periods of oversupply, but they've never had to deal with a global wave of deflation before. This will probably try their resolve as nothing has ever done before.”
Zimmerman warned that the situation could bring a serious rise on gas prices once things begin to stabilize. “This is not sustainable. Because as soon as the global economies recover, and they eventually will, we'll probably be in a worse pickle than we were in the summer,” he said.
“If they cut production enough to meet the global demand levels, that will stabilize things because it will gradually work off the excess production, bring supply and demand back into balance, and steady up the price.”
The production cuts are set to help stabilize the oil market and to stop prices from falling further. Kamran Bokhari, director of Middle-East analysis with Stratfor, a geopolitical intelligence and analysis company, explained that production cuts may not have a significant impact on prices.
During a phone interview, Bokhari said that the last budget cut actually drove prices down. “Last time, the cut that was announced, it really didn't amuse the market. In fact, right after they announced the cut, there was like a $4 plunge in the price. So it didn't have a whole lot of effect.”
“Here's the catch. If you announce a production cut, it's not actually the same as implementing it because the cartel as a whole will announce a cut, but there's not that discipline in the organization where every member will cut by the amount it's been asked to,” he said.
Although many are enjoying cheap gas prices, some exporters have been placed in a serious situation. Bokhari said that it’s possible that lowering oil prices are being used by Saudi Arabia to drive other oil producers out of the market.
Saudi Arabia has a budget that is based on $45 per barrel of oil. They also currently have a buffer of over $1 trillion. Other countries such as Iran and Venezuela, whose minimum is around $60 per barrel, are in a dire situation.
“The Saudis are in a much more comfortable position. They are the largest oil producer in the world. They practically run the cartel. They are the major player and pull all of the strings,” said Bokhari.
“It's in the Saudi interest for them to say let these prices stay where they are a bit longer so as to weaken Iran,” he said. “It's a matter of calibrating what is the best price range where they can hurt their rivals while at the same time meet all of their requirements.”
“It's done this in the past, such as in the 80's which lent to the fall of the Soviet Union, they flooded the market with oil and the prices were low enough to bankrupt potential adversaries. You don't even need to flood the market right now. You just need to maintain excess oil that will keep the prices low. It will hurt the other guys while you still have a cushion.”
The OPEC is an intergovernmental organization comprised of 13 oil-exporting nations including Iran, Saudi Arabia, Venezuela, and Algeria. It was founded in 1960 with the purpose of consolidating oil policy and pricing so as to stabilize the market.