Will the oil production cut help Opec again?

Last Friday, the Organization of the Petroleum Exporting Countries (Opec) decided to cut production by 1.5 million barrels daily— or 75 million tonnes (mt) a year— in the hope that it could arrest the fall in oil prices. It may be recalled that crude oil prices plummeted from a peak of $140 (Rs6,972) a barrel in July this year to just $64.34 last Friday. Despite the announcement, prices kept climbing down to $63 at the time of writing this column.

Opec likes to believe that it can arrest the fall in oil prices. It realized its clout four decades ago, when it suddenly increased the price of oil, giving the world its first oil shock. Then it did so again in 1996-97 when it hiked the price of oil by $6-10 a barrel. This continued periodically, and prices went up in 2007 as well. But the increase in prices during October 2007 and July this year was dizzyingly steep . Till the decline began.

Opec wants prices to stay above $80 a barrel—almost at the level they were at in October 2007. Venezuela wants them at $95. Iran, which subsidizes oil prices at home, wants them high, because they fund its military plans. But the markets have currently kept them at the same levels they were in March-April 2007.

So will the production cutback work? There are two views. Opec believes it will. But many market watchers say they won’t. The primary reason is the declining clout of Opec. Over the past four decades, the organization’s share in the world’s oil production has declined from three-fourths to just 40%.

Moreover, thanks to the attractiveness of oil prices, even at $40 a barrel, the prices are attractive enough for many more countries to keep investing huge amounts for discovering and producing more oil and gas. And this investment trend continues with increasing ferocity, especially in Russia, Kazakhstan, the Arctic regions, India, Indonesia, Malaysia (where many Indian companies have taken up exploration and drilling rights) and offshore regions of both North and South America. This is likely to push down Opec’s share even further. It is the classic Achilles heel of producer monopolies. When prices become attractive, other producers emerge, creating more supply and more competition, thus further weakening a monopoly.

Many market watchers agree. “We expect oil prices to remain around $70 a barrel,” says Yudhishthir Khatau, managing director, Varun Shipping Co. Ltd, whose ships are largely in the oil and gas transportation business. He, like many market watchers and economists, says that three factors will not allow oil prices to climb much higher in the near future. First, oil stocks in most countries are healthy. Second, because this is the lean season for oil consumption, though prices could strengthen during the winter months. Third, recession in Europe, China, and the US may force reduced offtake of oil.