Oil Prices Fall Amid Signs of a Market Glut
While the major military powers have convened in the Persian Gulf to assure the flow of oil from the Middle East, the oil world itself seems to have forgotten the tension. Oil prices continued a steep decline Monday amid signs that the market was again glutted.
By the close of the trading day, some prices for crude oil had dropped below the levels that prevailed before OPEC’s last meeting, in June. But traders and analysts were speculating that the bottom may have been reached.
The decline, to the $18-a-barrel range from a peak of $22.75 as recently as mid-July, could knock a few cents a gallon from the price of gasoline, analysts say. The fall could also weaken the hand of the Organization of Petroleum Exporting Countries as winter nears and OPEC tries to boost its official prices.
But few economists expect another price collapse like the one that drove down inflation and rocked the oil industry last year. There was some evidence that Saudi Arabia, believing that prices went too high too fast last month, was moving to regain control.
OPEC leaders have begun to discuss some sort of intervention to bring overproducing cartel members into line so that prices do not fall too far. Some OPEC watchers said that the mere discussion of such a step would prompt some members to turn down their spigots.
“Only the good Lord knows, but my guess is we may have even tested the lows today,” said Sanford C. Margoshes, international oil analyst at the investment firm of Shearson Lehman Bros. in New York. “I don’t think it’s going to get out of control.”
Prices plunged as much as 75 cents a barrel for the key U.S. crude oil, West Texas Intermediate, before recovering to end the day off 30 cents at $18.60 a barrel--a four-month low--on the New York Mercantile Exchange. The prices are those paid for oil to be delivered in October.
In Britain’s futures market, prices for a key type of crude pumped from the North Sea tumbled by $1.05 a barrel to $17.20.
Analysts said both markets were reacting to news from a Cyprus-based newsletter, the Middle East Economic Survey, which said OPEC members are producing 19.7 million barrels a day this month--or about 3 million barrels more than their quotas allow.
The quota of 16.6 million barrels a day and official average prices of $18 a barrel for various grades of OPEC crude oil are part of the system implemented by the cartel over the last six months to gradually bring prices back up after the disastrous collapse of 1986.
The price-fixing accord succeeded in raising prices from $10 a barrel a year ago to the $18-to-$20 range by early this summer. But, at about the same time, military tension accelerated in the Persian Gulf and some OPEC members began to produce above their individual quotas.
Transfixed by the dangers posed by U.S. naval vessels escorting Kuwaiti oil tankers past Iranian missiles and mines, oil traders ignored the overproduction and drove crude prices up in anticipation of an interruption of supplies through attacks on tankers.
“Now we’re focusing on the overproduction and on the fact that the U.S. is basically ensuring the safe flow of oil through the gulf,” said John Hill, a trader for Merrill Lynch Futures in New York.
Monday’s report by the Cyprus newsletter was only the latest of many signs that OPEC is producing too much oil, but it was regarded as the most authoritative because the newsletter is considered to have close ties to OPEC’s biggest producers, the Saudis. It was also considered a sign that Saudi Arabia is stepping up its efforts to police the cartel.
Saudi Warning Shot
Disclosures that the Saudis themselves are among those producing above their quotas support the theory that Saudi Arabia is firing a warning shot across the bow of its OPEC colleagues. Its enormous oil reserves and unused production capacity give Saudi Arabia the power to flood the market and drive prices down, as it did in 1986, an event it could withstand much more easily than other members of the cartel.
The Saudis are price moderates within OPEC who believe that rapid run-ups in oil prices damage their cause over the long term. Many analysts believe that Saudi Arabia hopes to set the stage for an official $2-a-barrel price increase when OPEC meets again in December. But that will be difficult if there is too much oil in world markets.
The midsummer spurt in prices above the official OPEC price was seen as an artificial spike, caused by military and political uncertainty, that was causing volatility in the oil markets. Also, it let OPEC members overproduce without the normal consequence, which would be a decline in prices.
“As long as prices were holding up, they kept on producing and selling more oil,” said Paul D. Mlotok, OPEC analyst at the Salomon Bros. investment firm in New York. “It was a lapse of discipline. We’ll see an improvement in discipline.”
The numerous holes in the cartel’s quota system--such as the habitual cheating by weaker OPEC members and the refusal of Iraq to abide by the ceiling--meant that OPEC leaders expected about 1 million barrels of “leakage” a day. The resulting production of 17.6 million barrels a day would have roughly matched the world’s demand for OPEC oil.
Tom Burns, the manager of the economic staff at Chevron, a major OPEC customer, said he was skeptical about the estimate of 19.7 million barrels a day of current production. But it is clear that the cartel is overproducing, he said, and every barrel above the world demand is being stockpiled.
“That means 30 to 40 million barrels a month has been going into storage. They’re producing their winter peak demand in summer. So, when winter comes, prices are going to be weak and not conducive to an official price increase.”
Last week, OPEC President Rilwanu Lukman, oil minister of Nigeria, raised the possibility of convening a three-member committee established at the latest cartel meeting in June whose job would be to jawbone quota violators into abiding by the ceilings. But he insisted that the reports of overproduction are “wildly exaggerated.”
Cheating by its members has long been OPEC’s Achilles heel. In this case, analysts say that members of the cartel have not been charging above the average official price of $18. Instead, they are producing more than they are supposed to, thus exploiting the gap between the cartel’s official price and the higher prices that have been available for oil sold on the so-called “spot” or futures markets, Burns said.
Moreover, energy economists estimate that only about half of all oil and oil products produced by OPEC are subject to the cartel’s “official” prices. Some oil is swapped for other products, and some OPEC oil is sold as refined products. Neither is subject to the cartel’s price and quota rules.
OPEC members are thus seizing on what they see as opportunities to bolster their domestic economies, which were so badly damaged by the 1986 collapse in oil prices from the $30 a barrel that prevailed as 1985 ended. The cheaters are said to include military foes Iran and Iraq, desperate to fund their war efforts, Kuwait, Saudi Arabia and the United Arab Emirates, among others.
