Jeremy Warner's Outlook: Opec struggles to set a sustainable oil price

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The Independent Online

With all the kerfuffle about the sickly dollar, the markets seem plain to have forgotten the supposed economic doomsday machine of only a couple of months ago - the soaring oil price. Since then, the price of crude has unsoared, with the cost of Opec's benchmark average falling by nearly a quarter. This is very welcome news for consumer nations but decidedly uncomfortable for members of Opec, who also have to reconcile themselves to the fact that the dollar, in which oil is priced, buys fewer euros, pounds and Swiss francs almost by the day.

Strange but true for an organisation which was so recently being urged to turn on the taps of production to ease a crisis in supply, some members are again arguing for a reduction in quotas. The oddity of their position is that although the price has fallen a great deal, it is still nowhere near being back in Opec's formal target range of between $22 and $28 a barrel. The weak dollar may have rendered this range meaningless, but for the time being it still stands, like a rusting old North Sea oil rig, a monument to a bygone era.

Asked at a Chatham House conference in London last week where he thought the price range should be, Saudi Arabia's oil minister, Ali al-Naimi, said producers would see a range of $30 to $34 as fair. Whether this week's meeting of Opec in Cairo will confirm these numbers is another matter. Whatever they decide, serious discussion of production cutbacks seems unlikely.

On the contrary, it is already plain that investment in new production capacity will have to be increased substantially over the years ahead if we are to avoid an eventual excess of demand over supply. Spare production capacity is already at record lows. If the world economy keeps growing at the rate it has done over the past year, then a long-term shortfall looks all but inevitable. Opec wants a higher price to compensate for the falling dollar, but it would do itself no favours at all if the consequence of a higher price is slumping demand. The world economy is not as sensitive to the ups and downs of the oil price as it used to be, yet oil still has the power to wreak merry havoc given half the chance.

GSK comeback?

Few were more sceptical than me about the supposed merits of Glaxo Wellcome's merger with SmithKline Beecham, and with the shares still languishing at close to seven-year lows I'd like to think my position has been largely vindicated. Time, none the less, for a reappraisal.One product in particular, should it prove as explosively successful as the company hopes, would more than make up for the past four years of disappointments.

To GlaxoSmithKline's chief executive, Jean-Pierre Garnier (known in the industry as JP), the poor performance of the share price has got much more to do with the rotten environment for the pharmaceuticals industry in general than the merger itself. He's adamant that without the £2.4bn of cost savings the merger allowed, the two companies would be in worse shape today individually than they are together.

We'll never know the truth of that for sure, but one thing does seem fairly clear - the drought in drug discovery at GSK seems finally to be coming to an end. The merger was always going to be judged ultimately on its ability to generate significant numbers of high-selling products to replace the old ones as they came off patent. When the two companies merged, their cupboards were pretty much bare, yet like a gathering tsunami, all of a sudden GSK seems to be in possession of one of the most promising pipelines in the business. A genuine transformation is promised over the next two to three years which Mr Garnier hopes will vanquish his critics.

All manner of problems have come crashing in on Big Pharma since the merger was signed off, from pricing pressures to patent challenges and a growing wall of questions about the safety of many of the industry's products. Yet by far the most serious remains the slowdown in the rate of drug discovery.

To prove the point Mr Garnier likes to quote the following data. In 1980, the industry spent $2bn a year on research and development. By 2000 that had risen to $26bn, yet the number of new drugs approved for sale by the Food and Drug Administration in the the United States was the same at just 35. It is hard to think of any other industry that has suffered such a calamitous decline in R&D productivity.

Much of the low hanging fruit of modern drug discovery has already been plucked and the industry is now on to much more difficult and costly therapeutic areas - the cancers, dementias and complex viral disease. This has been accompanied by more demanding and infinitely more expensive regulation as to efficacy and safety. The balancing act that must be performed between risk and benefit seems to have tipped decisively towards limiting the former.

The primary justification for the GSK merger was that it would help to turn the tide on new product discovery. Regrettably, this has become a bit like waiting for Godot, thus far at least. With three major product launches due over the next year, the promised tsunami may finally be about to hit the beach. Yet it is the year after, in 2006, that the real action arrives in the form of a new vaccine against the virus that causes the most common form of cervical cancer. Recent tests show it gives 70 per cent protection against all forms of cervical cancer, the biggest cause of cancer death among women after breast cancer. This is a product that understandably has JP visibly excited. Having lost nearly $2bn of sales to generic competition over the last year, Cervarix, as the product is known, seems the answer to his prayers.

There's still scope for things to go wrong, even though the product is at an advanced stage of development, but the potential is mind boggling. Once you know the facts, it is hardly surprising that privately JP has been describing Cervarix as the biggest thing to have happened to the company ever. Many states in Europe and the US are likely to make the vaccine mandatory between the ages of 15 and 55. Assuming it is priced like other vaccines the market would be worth $60bn to $80bn. Substantial take-up in Asia would double the size of the market again.

GSK is not alone. There are at least two rival products at similar stages of development. Yet even assuming GSK takes only a third of the market, the difference it will make to the company is huge. It's always dangerous with pharmaceuticals to invest too much hope in a single product. Furthermore, this is an industry in the midst of a maelstrom of change. Changes to Medicare in the US, in particular Bush Administration plans to make drugs freely available to the low-income elderly, may put severe downward pressure on drug prices in general.

Still, there's not a lot JP can do about that. On the thing he can do something about, new product launches, it seems that he is about to deliver.

Turner & Newall

Well there's a thing. The offer by the American financier Carl Icahn to keep funding the Turner & Newall pension fund, albeit on derisory terms, has been withdrawn, leaving the trustees with little option but to keep soldiering on until the Government-sponsored Pensions Protection Fund comes into existence next April, when they can collapse in a heap and ask the PPF to take on their £500m deficit instead.

With Courts gone and Jarvis now hovering on the brink, the liabilities awaiting this yet to be born compensation fund are queuing down the street. Funding for the PPF, through a planned £350m annual levy on the pensions industry, already looks hopelessly inadequate. The way things are going, the fund will start life more insolvent than the pension schemes it is meant to be there to help. Like everything else about the Government's pensions policy, it's a complete dog's dinner.

jeremy.warner@independent.co.uk

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