Happy Holidays from OPEC

opec121608.jpgSo far there’s been no shortage of smiles.  As OPEC members prepare for the big meeting tomorrow in Algeria, all eyes are suddenly looking toward the Russians in an attempt to gauge how much production they will agree to cut or what degree they will verbally express their agreement with the cartel’s plans to push the oil price back up from its 70% collapse in value from July.

Heading up the Russian coalition is of course Deputy Prime Minister and Rosneft head Igor Sechin, whose arrival in Orun will be carefully studied, and could represent Russia’s first definitive steps toward a new kind of relationship with the exporter’s group, one in which Moscow could selectively agree to participate in certain measures, but stopping short of being bound by obligations to the cartel.  As the largest oil producer outside of OPEC, the attendence of Sechin to this meeting, his second meeting with the group since Sept., is a considerable and unprecedented development.

But is it all just for show?

Just a few hours ago, a Saudi oil minister announced that OPEC would like agree tomorrow to cut production by two million barrels a day (the most drastic suggested output cut in decades) – something that David Ernsberger of Platts says would be an “overreaction” given some of the very recent output cuts which failed to raise the prices, and that no matter what OPEC does this week in Algeria, the bearish market will continue to hold and that $40 a barrel may not be the lowest we’ll see.

Nevertheless, the threat of Russia’s participation in OPEC’s monopoly games does indeed raise the stakes, and give the cartel one more important additional move.  Experts say that if Russia were to cut production by just 500,000 barrels per day, pressure would be taken off other OPEC members whose budgets are getting stretched very thin (Venezuela and Iran – something which speaks volumes about the political economy of oil and authoritarian regimes).  Vagit Alekperov of private firm Lukoil suggested earlier this week that his company expects to slash production by about 200,000-300,000 barrels a day.

The truth is that Russia would much prefer to do what it has always done – enjoy the benefits of high prices which are generated by OPEC, while still be free to maximize production during periods of record high prices.  For this reason, it could also be argued that Sechin and Co.’s visit to Algeria is as much show as it is substance, and in terms of long-term cooperation with oil cartel, the relationship may become harder to sustain once the exporters get some pain relief and we see oil cross the $75 a barrel line.  There is a reason, after all, why it was a Gazprom chief Alexei Miller, who without any quantitative data made a highly public prediction for the highest oil price anyone has ever committed to record ($250).  For many years now, the Russian state has had an intimate understanding of the media sensibility which can sometimes drive energy prices.

It’s commonly acknowledged that Russia needs oil to come back up to about $70 a barrel in order to balance the state budget – and that the government is under extraordinary pressure to do whatever necessary to get back on track.

But the current low demand is not likely to be shaken up by production cuts or even promises of Russian acquiescence.  Too many people are stockpiling supply, and waiting for prices to go up before selling.  India and China, whose continued economic growth is really the main driver to push oil prices back up, don’t look like they are quite yet ready to recover.  What can happen from an “overreaction” is that we will face shortages once again in the future because of severe under-investment in production and refining during this temporary period of low prices.

Why so much volatility over the past year?  An interesting explanation comes from Nick Butler at the Financial Times, who argues that the price swings have never been about supply or demand, but rather the primacy of fears and expectations over physical realities.  Butler advocates for a new system of rules, to endow the energy trade with stabilizing mechanisms:  “The most effective mechanism would be agreement on a broad target rangefor prices – say, between $50 and $75 a barrel – backed by a strategicstock holding to be augmented or deployed when prices diverged from therange. To support such an agreement trading would be limited to thosewith a direct physical interest in the market.

Butler may or may not be right about giving the speculators the boot, but one thing that we can all agree on is the extraordinary damage that can occur when we lack transparency, and how much investors in production need to be able to count on the protection of an equitable forum if and when disputes arise.  It is precisely in this area where Russia could do so much to become an energy leader, establishing greater security of supply while at the same time reducing volatility – but it’s hard not to feel pessimistic about the potential political will.

Photo: Algeria’s Oil Minister and OPEC President Chakib Khelil (front) gestures next to OPECOPEC will agree on a deep supply cut this week to try to prop up prices. (Reuters Pictures)