• SEPTEMBER 25, 2001

Energy: Cartel in catch22

It's been volatile times for oil markets over the past fortnight. Prices of the commodity skyrocketed to a 9-month high of $31 / barrel on news of the terrorist attacks. Since then, prices have cooled down to $26 / barrel. But nervousness still persists, as retaliatory action against Afghanistan could adversely affect oil supplies.

Life of oil traders has been made more difficult, as forces pull the markets in diametrically opposite direction. The possibility of military action against suspected terrorist outfits, which are mainly holed up in the Middle and Central Asian region could disrupt oil supplies. Consequently, oil prices would tend to remain firm. On the other hand, the attacks have only accentuated the weakness prevailing in the global economy leading to softening in oil prices, as demand declines. These contrasting variables could lead to a banding market with poor visibility over the near term.

That said, one can expect retaliatory action to be a longish term exercise and not necessarily in the form of military action. First salvos could take the form of crackdown on terrorist financial network and intelligence infrastructure. Meanwhile, the sliding global economy could continue applying downward pressure on oil markets. Consequently, tilting the balance in favour of softer prices. In fact, on the same reasoning, oil prices fell sharply yesterday touching 17-month lows before closing at $23.2 / barrel (Brent blend).

World Oil Reserves
(bn barrels) 1989 1999 2000
OECD 119.1 85.9 84.8
OPEC 764.9 802.5 814.4
Others 188.4 166.2 166.7
  1,072.4 1,054.6 1,065.9
However, the Organisation of Petroleum Exporting Countries (OPEC) has adopted an oil pricing mechanism to maintain prices in the band of $22/ barrel to $28/ barrel by adjusting production with preferred pricing of $25/ barrel. With a weakening global economy the cartel cut output thrice this calendar year by an aggregate 3.5 m barrels / day (mbd) to support oil prices. The latest cut of 1 mbd came into effect in September '01. As per OPEC estimates, for 2002, non-OPEC production is expected to be 49.2 mbd, which indicates OPEC production is expected to meet 35.6% of global demand. In the current environment the cartel also faces a conundrum, as key members having forged alliance with U.S may not be able to support a production cut. Tightening the taps in this delicate environment could label the cartel, once again, as 'price hawks'.

The table indicates the increased dependence of the global economy on OPEC supplies. In fact, reserve life expectancy is heavily skewed towards OPEC. While non-OPEC reserves have an estimated life of 12.3 years, OPEC oil has a life of 74.3 years. This suggests ominous overtones for the world economy. Consequently, foreign policy of nations could be designed to address this issue.

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