OPEC faces fresh dilemma in setting oil targets

John W. Schoen Senior producer • Profile • E-mail

With demand slowing and supplies rising, the world is awash in oil — sending prices crashing by more than 50 percent from a record high of $147 a barrel just three months ago. That has prompted oil producers to convene an emergency meeting to try to regain some control over prices.

But as OPEC ministers sit down Friday in Vienna to decide on production cuts they face a number of thorny obstacles to regaining control of the market.

The bursting of the oil price bubble has been as dramatic as the financial crisis that exploded onto the scene in early September. The two events are related: As the crisis has heightened the prospects for a deep global recession, energy prices have plunged on the expectation of lower demand.

Already demand for oil is down 8 percent from year-ago levels. As a result, oil supplies have begun backing up; stocks of crude have risen more than 7 percent in the past month.

“The oil market is shrinking right now,” said Paul Sankey, an energy analyst at Deutsche Bank. “The level of demand destruction in the U.S. is very, very significant. We think the global oil market will be not only lower this year but also very likely lower next.”

With oil revenues crashing, the 13-nation Organization of Petroleum Exporting Countries is trying to decide how much to cut production to try to keep prices from sliding further.

OPEC's control of the world's oil production has declined over the years as non-OPEC producers like Russia have expanded output. OPEC produces about 40 percent of the world's oil, while Russia alone produces around 11 percent. OPEC officials met this week with Russian President Dmitri Medvedev to discuss coordinating production targets but failed to win a commitment.

Even in the best of times, managing production levels to keep oil demand and supply balanced is an imperfect science. With the financial markets in turmoil, and the economic outlook cloudier than it has been in decades, the decision about how many barrels to produce will be extremely difficult.

To begin with, high energy prices on their own have been battering the world economy and could do more damage — even at current, reduced levels. If OPEC tightens too much, and prices remain too high, that could produce a deeper global recession and send demand falling further.

“Any (production) cut will just delay an eventual upturn in demand,” wrote Cameron Hanover energy analyst Peter Beutel in a note to clients. “OPEC thought the world could afford high-priced oil; now it can’t even afford what just a short while ago might have seemed like moderate prices.”

High oil prices also have spurred efforts around the world to develop alternate sources of energy. If OPEC producers tighten supplies and keep prices at elevated levels, they will help accelerate the process of weaning the world off their major source of revenues.

There are also a number of variables that are outside of OPEC’s control. The recent strength in the U.S. dollar, as investors fled to the relatively safe haven of dollar-denominated Treasury bills, has helped cut the price of oil in dollar terms. Another major wild card is the weather. No matter how poorly the economy performs, a colder-than-normal winter heating season could help prop up demand.

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