Where oil prices are heading

Ministers within the Organization of Petroleum Exporting Countries, which supply 40% of the world's oil, appear ready to back a cut of a million barrels a day or more in a bid to soak up excess supply and protect their own budgets. Officials say the cut could come in two stages -- some of it now, and the rest in December, when the group plans to meet again.

But the cartel has a mixed record in trying to stop sliding prices by cutting supply, especially in the face of a strong recession. The group failed famously in 1998, when it lopped off 2.5 million barrels a day in the midst of the Asian financial crisis, and had only spotty success in 2001.

Falling demand for oil in the U.S. and Europe this year has been a significant force driving oil prices down more than 50% from their record highs this summer.

Deutsche Bank, in a report Monday October 18, predicted that anemic 1.2% growth in the world's economy next year could drive oil prices as low as $50 a barrel -- roughly a third of their summertime high.

Oil at that price would cause pain across much of the cartel, where government spending has ballooned. An International Monetary Fund report released Monday said that Iran requires oil to average $90 a barrel this year to avoid deficit spending. Bahrain requires $75 and Oman, $77. Iraq, which the IMF says needs oil at $111 a barrel to balance its books this year, is already looking at ways to curtail spending in 2009.


Historical chart of changing OPEC's production quota
Chart courtesy of WSJ
Some oil-consuming countries have begun to caution against an OPEC cut, arguing that the world economy needs the boost of lower energy prices.

A decision to trim production will raise the perennial question in the cartel of who should do the cutting. Nigeria, Iran and Venezuela, who are already under growing fiscal pressure, will be loath to cut back their own output even in the face of falling prices. That job will fall largely to Saudi Arabia, OPEC's largest producer by far. The Saudis until now have been hesitant to reduce output this year, but analysts say the kingdom is serious about ensuring that prices don't fall below $60 a barrel.

OPEC often doesn't live up to its promises to trim or add barrels. In 2006, the cartel said it was going to cut 1.7 million barrels a day but trimmed far less than that. Similarly, OPEC ministers could try to send a message to the market by announcing cuts, even if the reality falls short of the pledge.

As long as oil is priced in USD, OPEC tends to boost oil prices when USD drops to keep its revenue steady. The recent movement in global markets are the global de-leveraging and force liquidation. Investors from entirely the world scrambles USD to save their assets; meanwhile hedge funds face money redemption and sell everything to meet its margin requirements. These all actions have been strengthening USD and Yen against other major currencies as the most liquid asset in the world at this time. As a result, oil prices has been pushing more down since then.

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Sources :

1. The Wall Street Journal: OPEC Expected to Cut Output In Bid to Prop Up Oil Prices, October 21, 2008
2. This Blog: 10/26/2008 - Analysis for the next week, October 26, 2008

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