Into the age of more expensive oil

As long as we need oil, Opec – or at least its members – will have an increasingly important role to play. And for the foreseeable future, we will remain dependent on oil for transport, by road, sea and air, as all use fuels made from crude oil.

It may well be that we are now into an age of more expensive oil than we have been used to.
So Opec has raised its members’ production quotas once again, and like last time – in Beirut in June – their action did not bring prices down very much.

Indeed this time, the price of crude oil rose shortly after the news emerged from the meeting in Vienna, as traders’ attention quickly turned to other concerns – Hurricane Ivan’s impact on US oil production and news of a decline in the country’s commercial crude oil stocks.

There is a temptation to conclude from these events that Opec does not matter.

In one sense it is a defensible argument.

In current market circumstances, when demand for oil is very strong and there is precious little spare supply capacity in the world oil industry, Opec certainly does not need to maintain discipline in restraining production to keep prices at a level acceptable to its members.

Opec ‘matters’

That is the role that has often been taken by Opec, with variable degrees of success, in times of weak prices.

But now, they all have a pretty much free hand to pump almost as much as they can, with the exception of Saudi Arabia.

But Opec certainly does matter now and perhaps even more in the future.

Had it not been for Opec’s willingness – in particular Saudi Arabia’s – to increase oil production this year, prices would be much higher. How high?

Paul Horsnell, head of Energy Research at Barclays Capital, says you can choose your own number, but it could easily have been pushing up towards $100 a barrel.

And although Opec now accounts for a bit less than 40% of world oil production, that share is going to grow.

Rising prices?

The organisation’s member countries utterly dominate known oil reserves. They account for more than three quarters of the total, the Middle East about two thirds and Saudi Arabia alone about 23%. And much of it is cheap to get at.

Outside Opec, new oilfields are increasingly in deep water or remote or difficult locations.

Within Opec, there is substantial support for the idea that the group should change – in other words raise – its price target.

The current objective for the group is a price band of $22 to $28 a barrel for something called the ‘Opec basket’. It is an average of seven crude oil prices, including, strangely, one non-Opec oil. The Opec basket is usually significantly cheaper than the main exchange prices given in the news, North Sea Brent and the New York Mercantile Exchange, NYMEX.

The price has been above the target band all year, and is widely viewed in the markets as lacking credibility.

The imminent US election perhaps made Saudi Arabia reluctant to complicate the vote by signalling that oil prices are going to stay rather higher

One major reason that prices can be too high even for Opec’s taste – and why there is an upper limit to their target – is the fear of undermining demand by causing an economic slowdown or a recession.

There have been some inconclusive signs of the economies of the US and China coming off the boil a little. But there is no sign that current prices are doing much damage to demand for oil. So Opec members probably feel they can get away with a higher price.

They discussed raising the target band in Vienna, but decided only to think about it further.

The imminent US election perhaps made Saudi Arabia reluctant to complicate the vote by signalling that oil prices are going to stay rather higher – such news never goes down well in the US.

Opec will likely return to this issue at their next meeting, in December in Cairo, with US domestic politics less of a constraint on their actions.

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