x Abu Dhabi, UAEWednesday 24 January 2018

OPEC has been down this road once before

As OPEC ministers bloc prepare for their latest meeting, current price volatility in the market mirrors situations in the past.

The price of oil has been steadily rising and looks like it may end the year close to $100 a barrel.
The price of oil has been steadily rising and looks like it may end the year close to $100 a barrel.

Just a few days before OPEC ministers gather in Quito, Ecuador, for their final meeting of the year, crude is again hovering near US$90 per barrel. Could this be a replay of the last quarter of 2007, when crude rose 19 per cent in three months from about $80 in early October to more than $95 by the end of the year?

So far, the trading pattern looks similar.

Three years ago, crude rallied strongly at the start of a bitterly cold northern hemisphere winter, as it is doing today. The only difference - which may or may not be a major one - is that it had already climbed from about $55 at the beginning of 2007, as OPEC spare capacity shrank. This year, crude has risen from about $80 per barrel two months ago, but has only recently strayed from a price band of $70 to $80 for any length of time.

There are other similarities besides the weather between the oil market of late 2007 and today. Then, as now, the physical market was not undersupplied with crude, yet prices were heading higher. That was at least partly because large oil consumers fretted that oil was becoming harder to find and more expensive to produce, and that in an expanding world economy, shortages were inevitable sooner or later.

Based on those expectations, and on US dollar weakness as the sub-prime mortgage fiasco began to undermine the nation's banking sector, investors piled into commodities, especially oil.

According to OPEC, such "paper investors", who bought and sold crude futures contracts without planning to take possession of physical oil supplies, were unwelcome speculators. The oil exporters' organisation blamed "market speculation" for crude's run-up to a record $147 per barrel in July 2008, and its subsequent five-month slide to below $34.

Oil-price volatility was bad for both producers and consumers, OPEC proclaimed. The organisation announced its major task was to stabilise the market by keeping the world adequately and reliably supplied with crude. In December 2008, the group pledged to remove a record 4.2 million barrels per day of output, or about 5 per cent of world oil supplies, from the market to stabilise prices.

Fast forward to the present, and it is remarkable how little has changed since the 2007 prelude to that period of record price volatility.

On Sunday Sir Richard Branson, the British businessman, predicted that crude would hit $200 per barrel, sparking unprecedented economic upheaval and mass unemployment. His projection was reminiscent of similar price forecasts in the first half of 2008 from the likes of Arjun Murti, the prominent Goldman Sachs analyst, and Alexei Miller, the chief executive of Gazprom in Russia.

Most notable among those recently reprising the 2007-2008 oil-consumer mantra, "the age of cheap oil is over", is Fatih Birol, the chief economist of the International Energy Agency. But others have sung similar refrains, including Barack Obama, the US president.

Another parallel with the situation in 2007-2008 is the re-emergence of international concerns about rising food prices and the extent to which higher fuel, fertiliser and transportation costs - not to mention competition between food and biofuel crops for arable land - are implicated in this escalation.

In his recently published book The Coming Famine, the Australian agricultural expert Julian Cribb warns of lower crop yields as farmers seek to cut their input costs.

On Monday, none other than the OPEC Fund for International Development announced a closer partnership with the International Fund for Agricultural Development to promote "innovative financing mechanisms to attract private sector investment in agriculture". The institutions called for "increased investment in agriculture to guarantee food security".

Since the link between energy and food prices seems solid, that development suggests OPEC itself may be worried that crude will continue to rise. This is not a development the group would necessarily welcome because it would increase the risk of another "speculative" oil price bubble forming and eventually bursting. But what can OPEC do to prevent this?

Raising the group's official output target in the absence of oil supply shortage is unlikely. Even a minor quota increase would encourage the less compliant OPEC members to pump crude at will, thereby flooding an already well-supplied oil market and triggering a price collapse sooner rather than later.

Behind closed doors, the energy ministers of Gulf oil states may urge price hawks such as Iran and Venezuela to stop calling publicly for $100 crude in what could become a self-fulfilling prophecy if market speculators pay heed. To bring those countries into line, Saudi Arabia, which now has ample spare capacity, might raise the prospect of a supply increase.

If the OPEC secretariat's market experts fear another bout of price volatility, they might urge closer co-operation with international oil companies in exploiting the world's remaining reserves of relatively "easy" oil.

Whether resource nationalist members such as Algeria and Ecuador, the meeting's host, are in a mood to listen may not become apparent for months or years. But such a strategy could have a long-term calming effect on the international oil market by rationalising the global exploitation of reserves. With more OPEC oil entering the market, the need to tackle "frontier" resources would be deferred, allowing more time for emerging technology to bring down costs.

In the meantime, the official word from Quito is likely to be that OPEC will once more wait and see how far this price rally goes before taking action.