OPEC Cuts: Will They or Won’t They? A Postmortem (Registration required)

Note: I have appended an update to this piece following the OPEC meeting March 15 to assess the near term implications of OPEC's decision not to cut production.

OPEC, the group of oil producing countries that together account for about 40% of global petroleum production decided not to maintain its past production cuts which aim to strip 4.2mbd in oil production from September 2008 levels. This decision was largely expected for reasons I outline below, including the fact that although compliance with past cuts is high, it is far from 100% and very unevenly distributed. OPEC believes that its cuts have succeeded in stabilizing the market but it is balancing weak demand and an uncertain economic outlook against its own revenue needs and concerns about contraction of the sector. Furthermore OPEC's decision to maintain its past production targets, may be part of what Saudi Arabia brings to the G20 negotiating table in a few weeks.

As to the price outlook, the demand outlook should continue to keep prices weaker than in recent years, but compliance with previous cuts is at least slowing the buildup of excess supply. Should OPEC actually remove the agreed supply from the market - and non-OPEC members reduce supply slightly too on lower prices, supply cuts will eventually stop the rise in crude stocks. A significant demand and price rise are likely dependent on a turnaround in economic trajectory, which does not yet seem to be in sight. Should the global recession really be as deep and protracted as we fear, the drop in demand might offset the supply erosion, keeping prices weak. By all accounts OPEC members are worried about demand, and they should be. The outlook for the global economy suggests that demand for oil and oil products will continue to fall, particularly in the OECD, but also in most emerging economies – and the pace of demand growth slowed sharply even in countries like China that accounted for much of the demand growth in recent years. 2009 is likely to mark sharp demand reductions for crude oil - and that suggests oil prices may continue to be weak despite production cuts.