Despite Rise,Oil Prices Likely to Remain Volatile : Influences Outside OPEC’s Control Expected to Keep Roller Coaster on Its Track

Last month’s mini-collapse in the price of oil was almost fully reversed by the weekend, supported by a declaration from OPEC that the cartel had produced 6% less oil in February than its quota calls for--fresh evidence that the oil cartel is prepared to sacrifice to hold prices up.

But many economists and industry experts believe that the oil price roller coaster is still out on the track and holds the promise of thrills and spills for months to come.

OPEC declared that it sharply cut oil output in February to 14.9 million barrels a day, compared to its production quota of 15.8 million. That and other news, including signs of dwindling U.S. oil inventories, suggested a tightening of supplies and helped drive crude oil prices close to $18.50 a barrel.

That is near the peak reached briefly in the heady weeks after OPEC agreed Dec. 20 to slash production and fix prices at about $18 per barrel of crude oil. But in February, on reports of OPEC’s January overproduction, prices of oil on spot markets had tumbled to the $16 range.

Partly because of the willingness of Saudi Arabia to cut production to as little as half its 4.1-million-barrel quota, abandoning its public posture of last year, the Organization of Petroleum Countries has since been able to return prices to the target range of $18.

“We don’t see that there is going to be any difficulty in maintaining the $18 price throughout the rest of the year,” said OPEC President Rilwanu Lukman of Nigeria.

Maybe so, but it could be a bumpy ride.

In addition to such factors as the current seasonal decline in demand and uncertainties surrounding the Iran-Iraq war, some students of oil pricing now contend that the long-established mechanisms for “legal cheating” on OPEC members’ production quotas have assumed a proportionately bigger role because of today’s lower price levels--adding another weakness to the multilayered “official price” agreement.

Moreover, even if OPEC holds to its December accord, analysts say the growing power of the oil futures and spot markets in the world’s complex oil-trading system virtually assures that prices will remain jumpy for months or years to come.

A few hold that OPEC does not have that much to say about prices any more, its role having taken a back seat to value of the falling U.S. dollar. And economists cannot even agree on whether a falling dollar pushes the price up or down.

“February was a mini-crisis, and there are going to be more of them,” said Paul Mlotok, who follows OPEC and the international oil companies for Salomon Brothers in New York. “Prices are going to be volatile for some time to come.”

The February drop in prices was prompted by, among other things, the news that the cartel had exceeded its quota by nearly 1 million barrels a day the month before. That supported the suspicion that the pact would be undermined by hard-pressed members of OPEC who would cheat by selling at a discount off the official prices in order to sell more oil.

The Saudis’ subsequent return to their role as so-called “swing producer,” cutting their own production to offset the cheating by poorer nations, has defused that problem for now.

But as with past OPEC fixed-price agreements, the current one affords opportunities to sell oil at discounts without violating the accord. And because the current prices are far below the $27-to-$31 range that prevailed in the past, the discounts have a proportionately larger effect, says Fereydoun Fesharaki, a one-time OPEC delegate and now research associate at the East West Center Resource Systems Institute in Hawaii.

Many of the discounts arise from the production-sharing agreements between OPEC member nations and oil companies. Under a typical arrangement, an oil company will agree to buy half the oil it lifts from a given field but at an “equity margin” of as much as $2.50 a gallon, Fesharaki said. The national oil company seeks to sell the rest to other customers at market prices.

“At $30 oil, an equity margin of $1 or $2 didn’t make that much difference. But with oil at $18, it can be a hefty amount,” said Fesharaki.

He estimates, and others agree, that perhaps half of all OPEC production is not even subject to the official prices. Some is in obscure grades of crude oil that have no competition outside the cartel, but that sold at “equity margin” discounts to production partners who can undermine the prices commanded by the OPEC member’s share of the oil.

Made Out Like Bandits

“If demand falls, it’s the (higher priced) government’s share that’s hard to sell,” Fesharaki said. “These are the first signs of a major problem.”

Meanwhile, energy economists increasingly regard price volatility as a hallmark of the times, even if OPEC or some other force manages to bring oil supply and demand into balance. This thinking stems from the increased attention given the prices paid for oil futures, or agreements to take delivery of oil at a future date.

More than one-third of oil futures contracts traded on the New York Mercantile Exchange are bought and sold by speculators who, according to Bijan Mossavar-Rahmani of Harvard University, “have a tremendous vested interest in price volatility.” A return to fixed prices inevitably reduces the trader’s chances to make money, he noted.

“The traders made out like bandits in 1986 because of the volatility,” said Mossavar-Rahmani, the assistant director of the Energy and Environmental Policy Center at Harvard’s Kennedy School of Government. “Consciously or unconsciously, the traders were talking down the market in February. One of the problems is the journalists talk to the traders.”

He was referring to financial news wires that report hour-by-hour the comments of traders and others on world developments, some of them obscure, that might affect oil supply or demand. These can drive futures prices up and down sharply in the same day.

“This is to be expected. This is a pattern of the 1980s,” said Mossavar-Rahmani.

He likened the price climate to “a yo-yo on a short string” and said that prices might bounce around in the $16-to-$19 range all year--stable by 1986 standards but volatile in an industry where a price change of 50 cents used to be a major event.

“I think OPEC will hold . . . but it’s not possible to hold to a very rigid price level,” he said.

Whether OPEC holds isn’t all that important to Bharat Trehan, an economist at the Federal Reserve Bank of San Francisco, who says that the recent sharp fall of the dollar against other currencies will tend to drive oil prices up. OPEC’s influence, Trehan says, is limited to the extent and timing of such upward movement.

Trehan’s theory is the opposite of conventional wisdom, which says that a falling dollar--the currency in which oil is traded worldwide--means falling prices. Many consider the dollar’s value to be a minor piece in the oil-price puzzle in any case.

Trehan says exporters who suddenly are getting less dollar for their barrels will react by withholding oil from the market, driving prices up. But other economists say that the exporters will flood the market, driving prices down.

The fact that historical trends back Trehan’s theory only means there is not enough history of a falling dollar to go on, says Fesharaki of the East West Center. But he adds, “It’s a sexy idea.”