Despite vows by OPEC cut oil production and prop up plummeting prices, the market isn’t persuaded that the cartel has much power. The 1.5 million barrel cut announced Friday would be one of largest in recent history—taking global output down by nearly two percent. But it’s far from clear OPEC can deliver those cuts—or that they will have much effect on prices.
The cuts themselves will be hard to engineer. Publicly, the cartel’s 11 members are unanimous that reductions are necessary: Iran and Venezuela especially are said to need oil prices at $95 a barrel simply to balance their bloated budgets. By cutting the number of barrels on the market, the cartel can shrink global supplies and push the price up from $60 range and back toward $100—in theory, at least. But in practice, OPEC hasn’t been very successful ensuring that all members cut their output at the same time. In times past, certain cartel members have cheated, pumping more than their assigned quota in the hopes of making up in volume what they are losing in price—despite the fact that such cheating only serves to drive the price down further. It was just such cheating by Venezuela in the 1990s that helped push oil prices into the single digits. Granted, Venezuela might not cheat this time around, given its desperate need for cash. But smaller members may try to add extra barrels to the market.
Further, if even OPEC does maintain the necessary discipline, the cartel will be working against an extraordinarily powerful trend: falling demand driven by recession. Already, US oil demand has fallen to its lowest level in nearly a decade, and market analysts expect the once-ravenous appetites of China and other Asian to falter as well. No surprise that Iran’s oil minister wants to cartel to cut an extra one million barrels in addition to the announced cuts. And yet, if OPEC is too aggresive in its cuts, it risks making the global recession even worse, and thus driving oil demand--and prices--even lower. Some experts see prices falling perhaps to $50--or barely a third of their record level this summer!
Time, however, is on the cartel’s side. The current price slump hasn’t come about because the industry has discovered vast new supplies of oil, or because industrial nations have become dramatically more energy efficient—but because of an economic slowdown. Eventually, howefger, the credit crisis will ease, and economic growth will return, and with it, energy demand. China, after all, has no plans to stop growing into an industrial power. Oil prices will creep back up, motorists will scream every time they fill up the tank—and OPEC will be struggling to find ways to pump more oil.