Opec acts to stop slide in oil price

News Analysis: The oil cartel has agreed a further cut in production. But will members cheat on the deal?
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The Independent Online
OPEC, the oil cartel, yesterday agreed to cut production by almost 1.4 million barrels a day, slightly more than market expectations, in an attempt to shore up the falling price of oil.

The reduction in oil output - which comes on top of the 1.3 million barrels per day reduction agreed just a few months ago - was welcomed by a market which has seen oil prices almost halve since the autumn.

But although traders seem united about the positive impact of the cuts in the oil price in the short term, many harbour doubts about their longer- term effectiveness.

One of the key reasons for the market scepticism is Opec's perennial problem of ensuring that members actually deliver on their promises.

Although it is collectively in the interests of Opec's members to cut back on production and so boost the oil price, each individual member has strong incentives to "cheat" on the agreement and produce more than the agreed quota.

The markets have watched Opec members fail to keep to agreed quotas time and time again and, not surprisingly, are far from convinced that Opec will come up with the goods.

"The numbers are impressive but can compliance control it?" said Peter Gignoux of Salomon Smith Barney.

Tony Machacek, oil futures broker at Credit Lyonnais Rouse, said: "If they are honest, genuine cuts, then this is enough to hold the market for a significant spell."

However, Mr Machacek pointed out that provisional estimates indicated that Opec members had failed to keep to the quotas agreed only last March, when the organisation said it would cut production by 1.245 million barrels per day.

Recent estimates suggest that Opec has in fact only cut production by 900,000 barrels per day, a fact that has done little for recent market sentiment.

The continuing crisis in Asia is another important factor in the equation. Analysts attribute much of the recent decline in the oil price to a fall- off in Asian demand.

Mr Machacek said: "A lot depends on the Far Eastern markets. They've been the real killer since the last quarter of last year.

"Assuming there is no substantial upturn in the Far East, a figure of $15 a barrel would probably be the top end in six months time. I'd say a range of $13 to $15 looks on the cards."

Oil was trading at around $14 a barrel in London yesterday, and traders said the price had firmed by $1-$1.50 since rumours of significant Opec cuts began to sweep the markets a few days ago.

Last week, oil sank to a 12-year low of $11.41 a barrel on the New York Mercantile Exchange, around half the price of a barrel of oil last autumn.

The Opec countries, whose economies are heavily reliant on oil revenue, have been doing their best to convince the market that, this time round, the cuts are genuine.

Analysts say that the very fact that the Opec countries are willing to reverse last year's decision to relax quota controls shows that there is a genuine desire to restrict output and support the oil price.

An Opec decision in Jakarta last year - taken just as the Asian crisis was beginning to make itself felt - raised cartel output limits by 10 per cent.

"This [yesterday's] agreement shows they have admitted making a serious mistake in Jakarta," said Leo Drollas of London's Centre for Global Energy Studies.

Insiders also see as significant the agreement by Saudi Arabia, the dominant Opec producer, to cut output to just above the psychologically important 8 million barrels a day level. Yesterday, Saudi Arabia agreed to cut production to 8.023 million barrels a day, a sharp reduction from the 8.76 million barrels quota that it secured at last year's Jakarta conference.

Of all the Opec nations, Saudi Arabia and Venezuela have agreed to the most substantial cuts in the two rounds of quota agreements made so far this year. According to yesterday's agreement, Saudi will cut production by another 425,000 barrels a day on top of the 300,000-barrel cut agreed earlier this year.

Venezuela is to cut another 325,000 barrels a day from output, on top of the 200,000-barrel reduction already agreed. Iran said it would make cuts of 190,000 barrels a day in addition to the cuts of 140,000 barrels made earlier this year.

Worryingly for the market, the first cracks in the recent show of unity by the Opec nations have already appeared. Concern has been circulating about politicking by Iran, one of Opec's most important producers. Iran recently announced hefty oil output figures, and the cynics believe that Iran used the announcement as a bargaining chip to try to minimise the supply sacrifices agreed to yesterday.