OPEC Revisited

OPEC Revisited

It”s been about six months since I did an OPEC update, so with

the cartel”s recent decision to lower production for the second

time this year, I thought I”d briefly review some numbers and

add a little commentary.

First off, just to refresh your memory, OPEC has 11 members

who, taken as a whole, account for about 40% of the world”s

production of oil. They are:

Algeria, Indonesia, Iran, Iraq (under sanctions), Kuwait, Libya,

Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela.

There are many large non-OPEC producers, such as Mexico and

Russia, who generally attempt to go along with OPEC”s rulings.

Non-OPEC production, of course, then equates to the other 60%.

World energy consumption last year was approximately 76

million barrels of crude per day. The U.S. consumes 19 million

of that and we import up to 60% of our energy needs, leaving us

in an extremely precarious situation should a foreign policy crisis

erupt in the Middle East.

Global consumption in 2001 was expected to be in the

neighborhood of 77-78 million barrels, but the worldwide

slowdown is forcing a reexamination of the numbers. Obviously,

if the current economic problems we are experiencing in the U.S.

don”t begin to improve, then demand across-the-board will

soften, maybe even to below 2000 levels.

Including production from Iraq (which is highly unpredictable

and inconsistent due to UN sanctions as well as Iraqi

intransigence), OPEC produced about 29 million barrels a day

last year. With the two cuts in production thus far in 2001, they

are now talking about a 24.2 million barrel target (not including

Iraq) with the objective of maintaining the basket of crude at

around the $25 level, roughly where it is today. *[Just a

reminder, West Texas Intermediate, the price you see quoted in

the paper and on television, is the most expensive blend. The

basket includes other grades such as North Sea Brent.]

OPEC is not stupid. They recognize that while $30-$35 oil fills

their coffers, it also can lead to major economic problems,

witness the impact of rising oil (as well as natural gas) over the

past 18 months in particular. OPEC is reducing production now,

however, because they believe that prices would plummet in the

second quarter, normally a down period for demand.

Additionally, the target price of $25 should ensure steady growth

in demand, but also discourage development of alternative

sources, such as solar and wind power. At least that”s the theory.

Putting it into practice doesn”t always work out.

There is also danger in a downward price spiral. While the West

may enjoy benefits such as rising corporate profits, it has the

potential to destabilize the Middle Eastern regimes which derive

on average 80% of their total government revenue from oil.

And, of course, $10 crude like we had in 1998 is not exactly

conducive to exploration for new sources. Thus, it sets the stage

for a shock to the economy such as the one being played out over

the past year throughout the world.

OPEC also gets a kick out of complaints from the developed

world when the price of crude rises substantially above the $25

price level. After all, taxes make up about 70% of the cost of

gasoline in Europe (24% in the U.S.). Lower your taxes, the

sheiks urge when the hue and cry goes up. And they have a point.

OPEC, after all, only receives about 20% of the cost of a

“refined” barrel of crude.

A few other points. Looking ahead, once we get through this

current economic malaise, which, admittedly, could take awhile,

the trend of increasing worldwide demand for crude will resume.

In coming years, we could even be facing a far more severe

crisis. To wit, China alone may have an additional 170 million

cars on its roads within two decades. Coupled with gains in

other developing nations, that could help lead to global

consumption of 115 million barrels a day or more. [And in these

cases, alternative energy sources will be far slower in coming

than is likely in the industrialized world.] Asia, in fact, which

currently imports 60% of its oil, may see that percentage rise to

90% by 2020. As I”ve mentioned before, the search for oil may

take on a military flavor one of these days.

In addition, oil from Persian Gulf states is likely to grow from 17

million to more than 41 million barrels by 2020, so their

influence will continue to be considerable and any political

turmoil in the region will undoubtedly have an impact on prices.

And then there is the issue of natural gas. Americans paid at

least 40% more, on average, than last year to heat their homes

and businesses this winter. And the trend does not look good

going forward. 64% of new homes built the past few years use

natural gas, yet the industry has not been able to keep up with

demand, ostensibly for the same reasons as oil. Low prices in

the past were not conducive to exploration for new sources.

And, now that there is at least a price incentive to invest in

production, we are faced with the fact that it can take up to 10

years to bring these new sources on line.

Aside from the situation in homebuilding, industry now accounts

for 40% of all natural gas that is consumed in this country and it

is estimated that an additional $150 billion in pipeline projects

are needed in the next 20 years to handle demand.

So we have our work cut out for us and you can see why, long-

term, many investment analysts favor the energy sector.

Sources:

William Drozdiak / Washington Post

David Hoffman / Washington Post

Daniel Yergin and Tom Robinson / New York Times

Michael Richardson / International Herald Tribune

Jim Nesbitt / Newhouse News Service

Sean Evers and Alison Flint / Bloomberg

Brian Trumbore