Lower Oil Prices and OPEC
Posted October 15, 2008 at 11:17 am 
Filed in: The IEA has updated its forecast for world oil demand for 2008 and 2009. Expected growth in oil demand has been revised downward for both years—240,000 b/d less in 2008 and 450,000 b/d less in 2009. Based on this latest data, global oil consumption will increase by only 400,000 b/d in 2008. You would have to go back to 1993 to find the last time a year-over-year increase in oil consumption was lower than half a million barrels per day.
As we pointed out in last week’s Chart of the Week, there is a strong correlation between economic growth and oil demand. We used the U.S. as an example to plot the relationship over the past four decades, but the correlation holds just as true (if not more so) around the world. As we head into 2009, weak economic fundamentals are rapidly driving down demand for oil in the OECD and in some emerging markets. Global economic growth is expected to be at or below 3 percent in 2009, a threshold the IMF has historically identified as indicating a global economic recession. In that environment, oil prices are quickly falling from their all-time highs reached this summer. At $75/bbl, prices are now about 50 percent lower than they were just 4 months ago.
Falling oil prices will have a number of consequences, some of which are beginning to take shape already. Bernstein Research points to one of them in this report on the future of OPEC. With oil prices plummeting, pressure will mount within OPEC to cut production. As Bernstein points out, countries with large government spending plans that depend heavily on oil for income are already clamoring for a significant production cut when the cartel next meets in November. Venezuela and Iran stand are among the most hawkish members; and with inflation in both countries expected to clock in at well over 20 percent in 2008 and 2009, both will need high oil prices to meet spending requirements. However, in an environment of weak economic growth, the OPEC hawks may have a hard time convincing other members to follow suit. In particular, it is not clear that Saudi Arabia will support a substantial production cut that damages its market share within OPEC while further driving down global demand. With a fiscal surplus equal to 10 percent of its GDP, Saudi Arabia can afford to maintain its current market share and absorb slightly lower prices while the global economy recovers.
If Saudi Arabia balks at a cut, then Iran, Venezuela, Nigeria and other OPEC hawks will likely be forced to go along for now—they simply cannot afford to cut production on their own. Therefore, the November meeting will be closely watched. OPEC has had a successful run in terms of holding discipline for the past decade, but with weak demand creating slack in the market and prices falling, we may be about to enter a period of significant tension within the cartel. If the Saudis do not want to cut production, a profound dilemma will confront some of OPEC’s members: why belong to the cartel at all?
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