OPEC Setting $60-plus Oil in Site

12/18/2006 12:06:29 PM

Opec is making good on its production cuts as expected, and the market is finally buying into the story after much skepticism. The price of oil traded down to just over US$55 per in mid November but has since rebounded as we expected.

Opec of course is drawing a line in the sand at US$60 per barrel. They have not stated so explicitly, but when the Saudi oil minister says he wants to bring the markets back to equilibrium, this begs the question “at what price?” for the market is always in equilibrium, however, until recently, it was clearing at lower prices.

It has been well expected that Non Opec supply was going to push prices down heading into 2007. After almost zero net additional supply in 2005, the IEA is calling for 650 kbd in 2006 and 1.7 mbd in 2007.

In response, Opec threatened to cut 1.2 mbd out of the market in November and called for another 500 kbd as of February 01st, 2007. In other words, Opec is looking to completely offset Non Opec supply in 2007.

So far 555 kbd have been taken out of the market in November according to the IEA who expected anywhere from 600kbd to 900kbd to be taken out of the market by Opec due to partial non-compliance. Saudi Arabia's Oil Minister al-Naimi said Opec members are complying with about 80 percent of the originally proposed cuts according to Bloomberg newswire.

Non Opec supply is running close enough to full capacity that they cannot simply open the valve a little wider to make up the difference. If Opec wants to make the market tight, they appear willing and able to do so right now.

Spare capacity is not that high for Opec, yet, despite the production cuts. The IEA estimates capacity at 3.8 mbd total and more like 2.4 mbd when they exclude questionable suppliers Iraq, Nigeria, Indonesia and Venezuela, thus not that high by historical standards.

Opec is therefore setting the stage for a tight oil market going into the winter months. Consider what the IEA had to say about the most November cuts in the December Oil Market Report:

“Without doubt, November’s output cuts have the potential to tighten the oil market this winter, and offer little prospect, allowing for demand growth, of a recovery in stock cover above the current 54 days; cold comfort for a risk-prone global economy already facing another winter with high oil prices.”

Given today’s proposed cuts by Opec, its hard not to be bullish on oil stocks heading into the winter.