London, 19 January 2011

OPEC's hopes for fostering stable expectations about prices have fallen an early victim of oil's surge to almost $100 per barrel, triggering a badtempered exchange of views between organisations representing producer and consumer countries.

But stung by criticism, and worried about the impact of high prices on the economy, key producers are quietly raising exports in a bid to cool the market. In a press release on the organization’s website, OPEC Secretary-General Abdullah al-Badri lashed out at the International Energy Agency (IEA).

He accused it of "supplying the world's media with unrealistic assumptions and forecasts (that) will serve only to confuse matters and create unnecessary fear in the markets. Ultimately this is adding to volatility in the oil market and destroying the stability that OPEC works so hard to support".

Badri attacked the IEA for muddled, inconsistent thinking on prices. "Either they prefer a high oil price, as indicated in their new policies scenarios, which they claim would curb oil consumption, or a lower oil price, which they claim would support economic growth" (see below).

It is all a far cry from the much-heralded convergence of views around $70-80 for much of last year. It was a level Saudi Oil Minister Ali al-Naimi suggested was "beautiful" for both producers and consumers. High enough to encourage investment in new oil fields and support deployment of clean technologies -- but not so high as to imperil the recovering economy or lead to a resurgence of anti-oil sentiment and policies.

Even in late November 2010, Saudi officials were welcoming a period of tranquillity in oil markets and convergent expectations that filtered out unrealistic expectations about either very high or very low prices and supported the stable pricing needed to plan long-term investments on both the supply side and demand side.

But amity broke down almost immediately when prices surged above $80 and producers refused to lift production curbs or accelerate the next review of market conditions, currently not scheduled to take place until June 2011. The IEA has warned prices are entering the "danger zone" and pose a threat to global growth. IEA Chief Economist Fatih Birol suggested "it may not be a bad idea that the producers are ready to increase production and show their understanding that these high prices are not good for the global economy" IEA head Nobuo Tanaka this week went further and stated bluntly "we are worried about the speed of the rising oil prices, which can harm the growth of economies ... If the current price continues it will have a negative impact". Tanaka warned: "OPEC needs to show more flexibility" OPEC fought back on Tuesday and raised a familiar complaint:

if consuming countries are worried about the effect of higher oil prices, why are they pushing through fuel tax increases?

CONFLICTING AIMS

The recriminations stem from inconsistent objectives and policies not only between the IEA and OPEC but within both groups themselves. The IEA is the conscience of the consuming countries. It was founded to promote coordination among consumers to counter the influence of OPEC and to prevent a recurrence of the extreme economic disruption associated with the oil embargoes and shocks of the 1970s and 1980s. In theory, the IEA tries to prevent excessive energy price increases.

But by dramatising the dangers of depending too much on imported petroleum, rising prices serve as a useful tool for advancing the IEA's long-term strategy of fostering efficiency, conservation and the development of cleaner, less carbon intensive forms of energy.

During the 2004-2008 price shock, the IEA sometimes seemed to take a Cassandrine delight in rising prices, warning consumers to embrace energy efficiency and a global warming agenda through extensive investments to curb use and promote alternatives to oil. In its role as long term guardian, the IEA became one of the chief cheerleaders for the rally. Short-term pain was a price well worth paying for long-term gain.

In 2009-2010, OPEC and the IEA appeared to reach a tentative consensus on the desirability of a price floor around $70 to protect cashflow needed for new oilfield development and to ensure clean technologies such as solar, wind and nuclear would remain competitive.

Prices above $70 appeared to satisfy the climate-change and clean-energy policies of the Obama administration in the United States, most European governments, and the environmental movement, while assuring producer countries of revenues and the resources to undertake long-term investments. Oil companies such as BP indicated $70 was sufficient to ensure the profitability of field development work.

While producer and consumer governments agreed on the desirability of avoiding low prices, there was never as much consensus about the desirability of avoiding very high ones, or at exactly what point prices would too high and merit action.

OPEC DIVISIONS

OPEC suffers from its own divisions. Saudi Arabia's concern about high prices threatening what the kingdom terms security of demand is sincere but not shared by other members of the cartel.

Price hawks like Venezuela, Libya, Iran and Nigeria are far too unstable to take a long-term view of prices and demand. Survival means they must focus on making the budget for the current year. Higher prices are a welcome windfall which increases the amount of resources available for patronage and strengthens the state.

Rising prices strain the cartel's cohesion because of the uneven distribution of spare production capacity. Of 4.65 million barrels per day of idled production capacity at the end of December 2010, according to the U.S. Energy Information Administration, only Saudi Arabia (3.75 million), and its Gulf allies the United Arab Emirates (300,000), Kuwait (300,000) and Qatar (150,000) had significant spare capacity.

Only Saudi Arabia and its three close Gulf allies can do anything to cool price increases by adding extra barrels. But while Saudi Arabia and its allies would offset some of its losses from lower prices through increased volumes, the hawks and the rest of the fringe have no such option. It is not surprising that the hawks do not favour production increases.

RIYADH RESPONDS?

While the kingdom's officials prefer to downplay their role, Saudi Arabia rather than OPEC as a whole is the swing producer in the oil market, at least when prices are rising, since the kingdom has almost all the surplus capacity. The decision whether to cool the market by adding extra barrels therefore falls to Riyadh alone.

But Saudi Arabia has been notoriously slow to react to price changes by adjusting its own production: (1) Saudi officials are reluctant to violate the consensus within OPEC by unilaterally changing their output volumes.

The cartel is a useful shield for Saudi production policy. More important, while OPEC does not play a swing role when prices are rising, it is a useful burden-sharing mechanism for allocating cutbacks when the market is under pressure.

(2) Saudi Arabia's oil policy has always been torn between targeting prices or physical market balance. Like any sovereign state, the kingdom dislikes being told what to do. It is especially reluctant to hand output decisions to speculators and the market, which it would have to do if it accommodated every change in futures market expectations and demand for inventories So the market searches for Saudi Arabia's pain threshold. In this instance, it may have found it.

"It appears Saudi Arabia has been making more crude available to the market in the past six months, judging by export data from the independent tanker trackers", according to the IEA. The agency claims Saudi exports rose 100,000 barrels per day in December and are set to increase further in January. Other Gulf allies are also raising exports, according to the IEA.

Unnanounced output increases and quiet slippage on compliance are the kingdom's best way to cool prices while avoiding an open showdown with fellow cartel members.

Ends --

OPEC Secretary General comments on recent oil market developments

Vienna, 18 Jan. 2011--"Oil prices have recently been driven by technical matters such as events in Alaska and the North Sea. Also, the weak dollar and speculation have added to this, pushing oil prices higher, especially Brent.

Any assumption that there is tightness in the market, however, is incorrect. In reality, commercial stocks remain well above the five-year average and forward covers stands at around 60 days. OPEC Member Countries are also holding more than six million barrels per day of spare capacity. At the moment, fundamentals show there is more than enough oil on the market.

Oil demand is improving; something that we welcome. This also indicates that the global economy is recovering - good news for us all.

OPEC, as always, is watching the market carefully. We remain committed to oil market stability. If there is a need for us to act, we will do so.

Supplying the world's media with unrealistic assumptions and forecasts will serve only to confuse matters and create unnecessary fear in the markets. Ultimately, this is adding to volatility in the oil market and destroying the stability that OPEC works so hard to support.

The IEA must be consistent in their remarks. Either they prefer a high oil price, as indicated in their new policies scenarios, which they claim would curb oil consumption or a lower oil price, which they claim would support economic growth.

In 2009, when the oil price was lower, the IEA had advised its members that they needed to increase petroleum taxes. So why, today, when they are complaining that oil prices are too high, are they not advising their members to reduce taxes? "

OPEC Secretary General, HE Abdalla Salem El-Badri