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COLUMN - OPEC leaves Saudis free to boost output: Kemp
June 9, 2011 / 4:52 AM / 7 years ago

COLUMN - OPEC leaves Saudis free to boost output: Kemp

-- John Kemp is a Reuters market analyst. The views expressed are his own --

OPEC building is pictured in the centre Vienna September 14, 2010. OPEC's failure to reach agreement on lifting quotas or oil production has exposed the organisation as a paper tiger. It confirms that market policy will be set unilaterally by Saudi Arabia and its allies. REUTERS/Herwig Prammer/Files

By John Kemp

LONDON (Reuters) - OPEC’s failure to reach agreement on lifting quotas or oil production has exposed the organisation as a paper tiger. It confirms that market policy will be set unilaterally by Saudi Arabia and its allies.

It means more oil will be supplied in the coming months, not less, and if anything is moderately bearish for prices.

OPEC Secretary-General Abdullah El-Badri told reporters the effective decision was no change in policy -- but that is not right. The effective outcome is to leave production decisions to Saudi Arabia and encourage an informal but substantial increase in output in the coming months outside the OPEC framework.

Even before the meeting broke down acrimoniously, the kingdom had already indicated it plans to raise output, whether or not the organisation changes official quotas and production ceilings. Saudi production will now rise, and the kingdom will probably be joined by its close allies, Kuwait and the United Arab Emirates.

The kingdom has shown a clear preference for preserving cartel unity. But unable to persuade its fellow members to agree to a big enough increase in output and ceilings to stem the upward pressure on oil prices, the kingdom seems to have decided there is less damage from going it alone than deferring to the sensibilities of other members and risking a further price increase.

The failed ministerial conference has pushed OPEC to the sidelines and will ensure oil supply decisions are made in Riyadh - unconstrained by the concerns of other cartel members. That probably means a more dovish approach that sees more barrels coming to market because Riyadh is far more concerned about the political and economic damage from soaring oil prices than Iran, Venezuela and some of the other cartel members.

Price hawks like Iran and Venezuela have overplayed their hand. Paradoxically, failure to reach a consensus means output will rise more sharply and openly in the coming months than it would have done otherwise.


According to Saudi Oil Minister Ali Al-Naimi, the conference split down the middle -- with four countries backing a proposal to raise output (Saudi Arabia, Kuwait, Qatar and the UAE) while seven were opposed (Algeria, Libya, Angola, Ecuador, Venezuela, Iraq and Iran).

The split mirrors the division of spare capacity. The only members of the organisation with surplus capacity are Saudi Arabia (3.22 million barrels per day), Kuwait (0.29 million barrels) and the UAE (0.23 million barrels), according to the Energy Information Administration, the statistical arm of the U.S. Department of Energy.

These are the only ones who can be considered true “swing producers” in the current climate. Other cartel members are bystanders. They have no ability to raise output in either the short or the medium term. But weak budgetary positions mean they cannot afford to cut production either.

In the run up to today’s sessions, the countries with surplus capacity made clear that they were determined to boost output in a bid to cool the market amid fears of a slowing global economy and demand destruction.

The only question facing the conference was whether other members would consent to an output increase to maintain the image of unity -- and whether Saudi Arabia and its allies were prepared to moderate their demands in a bid to secure that support.

In the end both sides seem to have calculated that break down was better than compromise.


For the Saudis, the breakdown leaves the kingdom free to use as much of their spare capacity as they want to cap prices. The cost of securing consent from Iran, Venezuela and the other five opposing countries must have seemed too high -- especially if it meant agreeing to a token increase that failed to impress the market.

The downside is the hit to OPEC’s cohesion and credibility. But for Saudi Arabia the risks of a small or no output increase obviously outweighed the damage of public disagreement. In any event the damage to cohesion is easily overstated.

None of the seven “refuseniks” has a good track record on compliance. If the central purpose of OPEC is to share the burden of cutting production during periods of oversupply, none of them has shared much of the burden in the past, so losing their goodwill has few costs for Riyadh.

In the current environment, with underlying oil demand growing strongly, especially in emerging markets, and severe constraints on capacity growth, Riyadh can be fairly sure it will not need support from other members of the cartel to cut production in the short or medium term.

The only real risk is rising prices trigger a worldwide recession, sending oil demand diving. In that case, Riyadh would benefit from support from other cartel members to cut output and rebalance the market (though how much help Iran, Venezuela and the others would provide is open to question given their poor track record on compliance with cutbacks).

But the best way to avert a recession and the risk of oversupply is facing down the price hawks and raising output to cool prices. Riyadh’s decision to ignore the opponents and press ahead with output increases is therefore not surprising. Only its threshold for walking away from the meeting was ever in any doubt.

Political calculations are also likely to have entered the kingdom’s thinking. Saudi Arabia is under immense pressure from the United States and its European allies to increase supply and limit further price rises. The U.S. recovery came close to stalling in May and President Barack Obama’s poll ratings have hit a new low according to press reports.

America may have proved an unreliable ally during the recent Arab Spring -- but Iran is the kingdom’s scarcely veiled enemy. Deferring to the cartel to win non-existent goodwill from Iran, and at the same time risk angering the kingdom’s biggest security sponsor, and imperilling the political prospects of the U.S. president would have made no sense.

By walking away from the meeting, and pressing ahead with big, unilateral output increases, Saudi Arabia demonstrates its continued usefulness to the United States and shows it is doing all it can to prevent further, damaging price increases. It will avoid blame if prices continue to spiral higher and the economy falters and can claim credit if prices fall.

Editing by Anthony Barker

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