OPEC cuts production for the third time since Sep 2008

It is just amazing to see the reversal of fortune for OPEC countries. From an all time high oil prices of nearly USD 150 per barrel in July 2008 to currently USD 40-45  per barrel. This is posing severe strains on these economies as they depend heavily on oil revenues. Till July there were pressures on OPEC to increase production to calm rising prices and now they are cutting production to protect falling prices.

On 17 Dec 2008, OPEC cut production for the third time since Sep 2008 by 2.2 million barrels per day. This makes it a total cut of 4.2 mbpd since Sep 2008.

 

Date

Cuts production by million barrels per day

Sept. 10 2008

0.5

Oct. 24 2008

1.5

Dec 17 2008

2.2

Total

4.2

OPEC raises concerns:

Having reviewed the oil market outlook, including overall demand/supply projections for the year 2009, in particular the first and second quarters, the Conference observed that crude volumes entering the market remain well in excess of actual demand: this is clearly demonstrated by the fact that crude stocks in OECD countries are well above their five-year average and are expected to continue to rise.

Moreover, the impact of the grave global economic downturn has led to a destruction of demand, resulting in unprecedented downward pressure being exerted on prices, which have fallen by more than US $90 a barrel since early July 2008. Indeed, the Conference noted that, if unchecked, prices could fall to levels which would place at jeopardy the investments required to guarantee adequate energy supplies in the medium-to-long term.

Like almost all variables in economics and finance, I haven’t managed to understand the movement in oil prices. In a paper on the oil market, I thought it to be a pretty much a high demand – low supply story leading to rise in oil prices. At that time I thought oil prices are here to stay despite recession impacting severely.

Why? Because the increase in demand was coming from emerging economies and mainly from China. Though Chinese economy is expected to slow down severely, I thought existing demand levels should persist or decrease marginally. Even at existing demand levels, the oil prices shouldn’t have fallen so severely as supply-demand gap would have been still there. However, what is being seen is a huge fall and it looks as if people have stopped consuming oil in a large manner.

Looking at these recent developments, it is amazing to see the role expectations play in shaping economic and financial varaibles. We usually focus on expectations from an inflation perspective but not much research is done on how it influences investment, oil prices etc etc. Managing expectation is surely the key.

One Response to “OPEC cuts production for the third time since Sep 2008”

  1. AcK Says:

    Small note…

    To understand the price movement, you need to look at two points…

    1. inventory data… when oil prices were at > US$100/bbl, OPEC had increased production to mollify US government, which was feeling the heat. The inventory build up has been quite huge (based on days of inventory).

    2. Speculation in commodity markets. Before asking the question that oil prices are two low, you need to ask what took prices to astronomical levels (US$150/bbl, almost twice the peak marginal cost of production of US$75/bbl). The answer is speculation. The reverse is also true. As an when the prices have fallen to crazy levels, and the short-sellers are caught on the wrong foot, prices will recovered. I believe US$45-60/bbl may be a good long term band, since I expect marginal cost of production (in Canada, oil sands) to settle at those levels.

    We may yet see US$25/bbl oil before any recovery. Hope this is useful.

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