Of opaque flows, cuts and prices

Oil prices have continued to fall, despite a decision by OPEC to cut production by 1.2 million barrels per day (bpd). The targeted production cut is 200,000 bpd more than what was expected. The oil cartel's decision to cut production shows their discomfort with the continued fall in crude oil prices and their anxiety to defend a floor price which is seen somewhere near $60 a barrel. Oil prices have fallen about 25 percent from the record mid-July level of $78.40 a barrel to below $60 now.

There are, however, doubts in the market whether OPEC members will be able to deliver the targeted reduction. The talk of a 1 million bpd cut has been doing rounds for about a month and was already factored in. So, when the OPEC ministers met in an emergency meeting in Doha, they decided to give a strong signal to the market by announcing a larger reduction target and hinting at the possibility of further cuts when they meet again in Nigeria in December.

OPEC members supply about a third of the world's crude and are concerned about high fuel stocks in consumer countries, particularly in the US, and a projected drop in demand for OPEC oil in 2007 as competitors bring in more supplies. The decision to cut the production is described by OPEC as aimed at restoring the ‘equilibrium’ between supply and demand, which has been distorted by ‘over-supply’ and huge inventory levels. The skepticism on the member countries’ ability to deliver the agreed reductions has come from the deep divisions seen within the cartel on how to implement the cuts. The targeted reduction comes at a cost for the member countries, particularly for those who have heavily invested their petrodollars into building up their oil sectors.

Market movements in the coming weeks will show whether OPEC will be able to define the current price level as the floor for the medium term. A large section of the market believes that there may not be any rise in the prices in near future and the current declining trend may continue, given the large existing inventories and the uncertainty surrounding the production cuts. According to a Bloomberg News survey conducted just before OPEC announced its decision, prices may fall next week on doubts the producer group will cut production enough to reduce excess supplies. 21 of 49 analysts, traders and brokers covered in the survey said prices will decline, 14 forecast an increase and 14 predicted little change.