Latest Deal Puts OPEC Credibility on Line

OPEC has promised a sweeping global deal to slash oil production and rescue the collapsed market, but now it has to show it means business.

“This is the last-chance saloon,” said Leo Drollas, chief economist at the Center for Global Energy Studies in London. “If they don’t produce a credible agreement, I think they will be consigned to oblivion, forever. No one will believe they can do anything, even in a crisis.”

Many analysts predict the package will start unraveling even before it officially takes effect on Tuesday--even though some of the oil ministers gathering in Vienna for emergency talks today will likely make actual cuts.

“This addresses the problem,” said Peter Bogin, an associate director at Cambridge Energy Research Associates in Paris. “It doesn’t solve the problem.”

OPEC and some newly found friends among non-OPEC producers, including Mexico and Oman, wowed the oil markets last week by announcing production cutbacks intended to pull crude prices off their recent nine-year lows. Norway has also indicated it might lower production.

The cheap prices have been a bargain for oil consumers but devastating for OPEC and other producers. The weak market has cost OPEC $15 billion in lost oil revenues this year, said Libyan oil minister Abdalla Salem el-Badri.

But after news of the promised reductions, oil jumped about $2 per barrel on New York and London futures markets.

But analysts say the rally was fueled by a psychological shift among traders who quickly could go the other way when actual reductions turn out to be less than promised. Nobody has yet removed a single barrel from the market, and once the cuts start, they may come up short.

A deal announced last week in Riyadh by Saudi Arabia (OPEC’s top producer), Venezuela (OPEC’s biggest quota buster) and Mexico was initially billed as removing 1.6 million to 2 million barrels a day from the glutted global market.

Analysts figure the real number might be just half that, and they say the Organization of Petroleum Exporting Countries will find its reputation on the line if it can’t deliver.

Venezuelan oil minister Erwin Arrieta, arriving in Vienna on Sunday, said OPEC would ratify its plans to reduce production but that it was too soon to say whether those who are cutting back should have to cut more.

OPEC created its own dilemma by agreeing in November to raise stated oil output by 10%, just as the Asian economic crisis and the mild winter in key heating-oil markets was stifling demand.

For years, the once-powerful oil cartel has failed to function as such, with members openly violating their production quotas and oil prices often widely missing the official target of $21 per barrel.

This week, OPEC is unlikely to tinker with individual production quotas, which now give the group an official production ceiling of 27.5 million barrels a day, experts say. OPEC is actually producing around 28.7 million barrels a day--and trying to dole out new numbers to all 11 members would likely turn into a nightmare of infighting.

Arrieta said last week that OPEC’s quota system “belongs to history.” Even if Venezuela cuts the 200,000 barrels of daily oil production it has promised, it would be producing 600,000 barrels over its OPEC quota each day.

If tiny Qatar cuts the 30,000 barrels of oil daily it has promised, it will still be producing 257,000 barrels above its quota of 413,000 barrels.

Experts doubt whether Nigeria will deliver the 125,000 barrels of cuts it has promised, and whether Indonesia, suffering a massive financial crisis, can cut the 70,000 barrels it has promised.

Drollas figures the producers need to cut 2.2 million barrels a day to prop up the market, and he predicts prices will begin to drift lower when traders see too much oil is still being shipped in April.