Oil prices at OPEC's mercy? - Views on News from Equitymaster

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Oil prices at OPEC's mercy?

Dec 14, 2010

Commodity prices are generally governed by the economic forces of demand and supply. But for crude oil prices, the dynamics of economic forces are rather superficial. For long, the oil producing nations have used the pricing of this scarce commodity to their advantage. OPEC, a cartel of twelve nations, has close to 40% share of the world's oil supply and two thirds share of its known oil reserves. The body is prompt when it comes to raising prices due to supply shortage. At times the shortage is even an artificial one. But when it comes to enhancing supply to meet excess demand, the profit centric motives take over.

In a recent meeting aimed to decide on viable supply limits, OPEC left the quota same as before. Oil prices are now at two year high of US$ 90 a barrel. While this means more inflation in the economy and slower recovery from global recession, OPEC is fine with the current state of affairs. It has shrugged off the high prices as a 'blip' and has left the quotas on hold citing slowing demand and strong supplies. The current supply limit is in place since last two years. It was fixed when oil prices plunged from US$ 147 to US$ 33 a barrel. OPEC justified the status quo in supply citing lower demand due to potential debt crisis in Europe. This is in complete contrast to IEA's report projecting rise in demand for oil from the fast growing emerging economies. OPEC's stand makes it clear that it wants to make most of the strength in oil pricing. The cartel had earlier estimated a price range of US$ 70 to US$ 90 being 'bearable' for consumers which was changed to US$70-US$80 in the recent meeting. The 'bearable' price range is altered to suit the convenience and pockets of the oil producers. Hence the inertia in raising supplies even if the rise in crude prices erode growth for a major part of the world.

The group has around 6 to 7 m barrels of spare capacity, but it has not changed formal supply quotas. Going further, if the supply remains fixed, oil prices will stay firm and the recovery of developed nations will be slower. For India, which imports close to 70% of crude oil, this means huge losses for oil refiners and high deficits for the government.

In the wake of the current events, the only fact that can ease concerns is a hike in share of non OPEC oil producing nations. Oil prices could also ease if speculative investments are not made into the commodity. However, for companies that are large consumers of the commodity, hopes of better margins could remain a distant possibility.

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