Why isn’t OPEC pumping more oil?

OPEC’s tight wad

Oil cartel’s refusal to pump more oil seems irrational, considering the soaring demand.

August 30, 2004: 1:19 PM EDT

By Fiona Maharg-Bravo, Breakingviews

LONDON (Breakingviews) – The Organization of Petroleum Exporting Countries (OPEC) says it is doing everything it can to stabilize oil prices.

The reality, however, is that it is doing precious little to relieve supply constraints.

The oil cartel, as a whole, drilled 6.5 percent fewer wells in 2003 than 2002. And while the likes of Saudi Arabia has lots of oil, it isn’t increasing investment to get it out of the ground. Yet demand for oil is soaring.

Considering that the International Energy Agency predicts that oil demand will increase 50 percent by 2030, OPEC’s behavior appears almost irrational.

But the appearance is deceptive. OPEC has two good reasons to keep supply constrained.

First, it isn’t entirely convinced demand will stay strong. It may be right.

At least part of the physical demand appears to be driven by countries buying and hoarding oil. Merrill Lynch believes that China, and to some extent India, are buying oil and storing it in fear of an oil shortage. This sort of panic buying pumped up demand during the oil shocks of the 1970s.

Second, OPEC countries need high oil prices just to keep their countries running. Indeed, they will need an average price of $31 over the next decade just to maintain spending programs, according to Goldman Sachs.

Saudi Arabia has run large budget deficits in the last two decades, averaging 45 percent of revenues. It needs oil revenues to pay down debt and support a rapidly growing population.

Supporting its sprawling royal family is an expensive business too. The cartel is relying on the oil price, rather than volume, to get its revenues.

OPEC may have been coaxed into supplying more oil in the past. But the cartel isn’t bent on doing the West many favors following the invasion of Iraq. And the macroeconomics don’t seem too risky; the high oil price hasn’t yet seriously dented economic growth or the demand for oil.

All in all, there isn’t much incentive for OPEC to increase supply when it meets in Vienna next month. That means prices are likely to stay above $30 over the medium term.

Of course, the price could drop below that if demand falters or there is more production from Iraq. But it certainly won’t be the work of OPEC.

Breakingviews is Europe’s leading financial commentary and analysis service. Its team of financial journalists comments on the most important financial stories of the day, as they break.

Find this article at:
http://money.cnn.com/2004/08/30/commentary/breakingviews/bviews_bravo/index.htm