Thursday, December 18, 2008

Market in disbelief

The market doesn't seem to believe OPEC compliance will be high.

The oil producers' cartel Opec has agreed to make a record cut in output, slashing 2.2 million barrels per day (bpd) from its current supply.

Opec has made two other cuts since September, meaning it has cut a total of 4.2 million bpd in four months.

Despite the record cut, oil prices continued to fall as US data provided fresh evidence of falling demand.

US light, sweet crude for January fell as low as $39.94 a barrel, its first time below $40 since July 2004.

The falls were blamed on US inventories figures, which showed that demand for petrol in the four weeks to 12 December was down 2.7% from the same period last year.

The price later recovered slightly to trade on the New York Mercantile Exchange at $40.31, which was down $3.29 from Tuesday's close.

Opec said that it hoped the record cut would boost prices but that it had no formal price target.

The cut means that the target for production for the 12 member states is now 24.845 million bpd. The cut is effective from 1 January, but the big question with Opec production cuts is always whether the member states will actually make the cuts they have agreed to.

"Given the still-substantial risks to demand and ongoing scepticism on Opec compliance, it could take some time before prices recover materially above $50 to $55 per barrel," said Gordon Gray from Collins Stewart.
Now here's some gibberish:
It is hoped a sharp supply cut will put oil on the path towards $75.

"You must understand the purpose of the $75 price is for a much more noble cause," the Saudi Oil Minister said. "You need every producer to produce and marginal producers cannot produce at $40 a barrel.

"Therefore we believe $75 is probably more conducive to marginal producers to continue so we don’t have a shortage in the market and we avoid the future rocketing of prices."
Let's set aside the possibility the statement is self serving. For the world's perspective it's inefficient for a low cost producer to cut output in order to raise price enough for a high cost producer to be profitable.

Someday demand will come back. What the oil minister might be getting at is will the marginal producers be ready when it does, or will there be a rocketing of price as we get this past summer? Daniel Drezner has that on his mine as well.

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