Saturday, May 21, 2011

QNB Capital: OPEC likely to keep quotas in June

The Organisation of Petroleum Exporting Countries (OPEC) will be meeting on June 8 in Vienna to review its oil production allocations. High oil prices may be having an impact on demand. This leaves OPEC with a difficult decision in setting its production targets, according to analysis by QNB Capital.

OPEC, of which Qatar is a member, aims to limit volatility in oil markets by adjusting its members' production targets. It last changed these targets in late 2008, reducing them following the crash in oil prices brought on by the global financial crisis.

Oil prices began recovering from mid-2009, and have risen substantially in recent months, largely because of concerns about the current events in the Middle East, but also owing to positive sentiment for the global economy. There was a sharp correction on May 5 when the benchmark Brent blend crude oil fell $12 in a day, the largest nominal daily fall on record.

However, this correction seems to have been speculative as it affected many commodity markets aside from oil. Oil prices still remain high compared with historic standards.

Fundamental supply and demand factors are important in determining oil prices. However, oil is also traded speculatively, or as a hedge against inflation. Therefore, oil prices can sometimes get out of touch with market fundamentals, according to QNB Capital, as happened in summer 2008.

Global oil demand is shaped by a mixture of long-term trends and short-term factors, such as oil prices. Consumption is gradually falling in most developed countries, with the US being a notable exception. This is a result of more efficient use of fuel as well as the increasing use of alternatives to petroleum products for electricity generation and to power vehicles. Meanwhile, consumption is rising in most developing countries, particularly those where populations and living standards are rapidly increasing.

The three most closely watched oil market forecasters all expect about a 1.5% growth in demand in 2011. OPEC's May report forecast an increase of 1.4m barrels per day (bpd) over 2011. Meanwhile, the US government's Energy Intelligence Administration (EIA) reduced its growth estimate by 120,000 bpd, bringing it in line with OPEC. Finally, the International Energy Agency (IEA) trimmed its expected demand growth from 1.5m to 1.3m bpd given the higher prices. This compares with growth of 2.8m bpd in 2010.

OPEC accounts for 40% of world oil production and its production decisions are therefore an important determinant of world supply. However, other factors also impact global supply. New fields come on stream and production levels rise or fall at existing fields, depending on the status of the oil reservoirs. Disasters or political turmoil can also affect supply. Production in Libya has fallen from 1.5m bpd to just 300,000 bpd in April.

OPEC therefore faces a tricky decision in balancing supply and demand. High prices have the potential to constrain economic growth in oil importing countries, which in turn could cause demand to fall below supply and result in a collapse in prices. If the easing in demand growth seen by forecasters is largely a consequence of high prices, then perhaps OPEC should increase production. But if that increase were to result in an oversupply then prices might also plummet.

QNB Capital said that OPEC is most likely to take a wait and see approach, leaving production targets unchanged in June 2011. Indeed, several OPEC oil ministers have made recent statements that the market is adequately supplied.

At most, OPEC may make some adjustments to address the issue of some countries producing more than their quotas, a practice that has increased as prices have risen. If so, this could result in small changes to headline allocation targets, but without the intention of increasing actual overall production.

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