Why OPEC Can't Halt the Price Slide

On the surface at least, the ambience at the OPEC meeting that began in Vienna on Sept. 26 was much the same as usual. Reporters lounged in hotel lobbies, ready to waylay ministers. Upstairs, OPEC delegates conferred over grilled marlin steaks and bottles of earthy shiraz. But behind the routine, there was a sense that OPEC may again be losing its grip on the oil market.

Although prices surged in the hours following the attack on the Twin Towers, they have plummeted in recent days by about 30%, to $21 per barrel. Traders suddenly are less worried about supply problems. They fear that demand could drop and that OPEC may be unable to respond in its usual fashion with cutbacks. "There is no question that the events of Sept. 11 have caused some definite impact on the market," says Ali Naimi, Saudi Arabia's Minister of Petroleum & Minerals. "Now, the market believes demand is going down as a result of these events."

To be sure, the likelihood of war in the days ahead and its effect on oil prices is unpredictable, particularly if a major producer such as Iraq gets hit. But unless the conflict causes a price spike, Naimi and his colleagues, including Saudi Crown Prince Abdullah, are in a bind. Falling growth will probably sap demand for the cartel's crude. Until now, OPEC might have responded by announcing cuts in production. To do so today, though, would put OPEC on the wrong side of the Bush Administration's war on terrorism. Case in point: Although Naimi bristles at the suggestion that he is under pressure from the U.S.--and he insists that the kingdom is observing its production ceiling--the Saudis do seem to be temporarily softening their position on price. "We are on the edge of [a fundamental shift in the oil market]," says a senior executive at a major oil company.

As a result, OPEC may be forced to accept a price far below the roughly $28 per barrel that Naimi has been trying to defend. Indeed, prices could tumble out of control if global economies worsen. "The question is whether they can avoid $14-per-barrel oil," says Roger Diwan, an analyst at Washington energy consultant Petroleum Finance Co. (PFC).

Adding to the heat on the Saudis to decrease prices is a growing conviction in the kingdom and in Washington that the Saudis bear some responsibility for the Sept. 11 events. Not only were a substantial number of the hijackers Saudi, but Saudi sources admit that funding for Islamic extremist organizations such as Osama bin Laden's has come from people in the kingdom. "The Saudi government let the situation get out of control," says Nawaf Obaid, a Saudi oil analyst.EROSION. In the longer term, much depends on whether the key alliance in OPEC--involving Saudi Arabia, Iran, and Venezuela--can survive the strains of the coming months. A major element in keeping prices near $30 for the past two years has been Prince Abdullah's decision to placate OPEC price hawks by supporting production cuts--at the expense of the U.S.

Already, that policy is being eroded. Although the oil cartel was supposed to cut its production by 1 million barrels per day in September, OPEC members are collectively producing approximately 800,000 barrels a day above its agreed ceiling. "`Positive cheating' is the rule," says Peter A. Gignoux, head of the oil-trading desk at Salomon Smith Barney in London.

The wild card is that it is difficult to know how much demand will drop. Currently, world supply is outstripping demand by 1.5 million barrels a day. If that imbalance continues for months, stocks would build up and depress prices even more.

Most OPEC countries can afford to put up with lower prices for a while. Saudi Arabia, Iran, Venezuela, the United Arab Emirates, and Kuwait have more than $500 billion in reserves combined, figures consultant PFC. But they had better conserve their savings. Much is uncertain, and the second coming of OPEC at the start of the 21st century may well be over. By Stanley Reed in Vienna

Power Delusions

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