$85 per barrel… What effect is this having? What is OPEC’s strategy?
Posted April 14, 2010 at 10:52 am 
Filed in: Oil prices are still rising. And, quite rightly, people everywhere are still talking about what is responsible for it, whether it is justified by fundamentals, and what effect it is having.
Here are a couple of additional thoughts:
Stifling Recovery
Yesterday, the New York Times reported on the Commerce Department’s monthly trade data. They highlighted that although imports rose 1.7 percent in February, imports of crude oil fell to their lowest level since 1999. This decline was attributed by economists to reluctance by struggling consumers and businesses to pay higher energy costs. One wonders how much stronger U.S. economic recovery would be if oil prices in particular were not continuing on a steady upward trajectory. (Prices have risen over 60 percent in the last 12 months, and 10 percent since February). If prices stay around $85, or rise even higher, just how damaging is this going to become?
Price Influencing
OPEC has significant power to influence the world price of oil. In recent months, OPEC’s official line has been that “prices around $70-80/b are essential to promote adequate investment without hindering the economic recovery.” Yet what we are seeing, illustrated by the first thought, is that there already appears to be some level of demand destruction appearing. (Demand destruction was also observed as prices raced towards their July 2008 peak of $147 per barrel). The Financial Times noted today just how quiet OPEC has been as prices have continued upwards, and how they continue to (at least publicly) push the $70 to $80 range as an acceptable (but perhaps not preferred?) level.
So what is the strategy here? OPEC does have sufficient production capacity to temper the upward movement in prices, but until there are clear signals that demand is being affected, they are probably unlikely to intervene and raise production. $85 per barrel oil is what one might expect the price to be in perhaps 12 months based on the resurgent oil demand growth of China and other non-OECD nations. It might be that the markets are simply factoring in the signals early (much like they do when they anticipate a bid coming for a company). OPEC, knowing that it gains substantially from these rises because the demand for oil is so inelastic. For example, at current rates of production, OPEC increases its yearly revenues by approximately $12.6 billion when prices rise just $1 per barrel—an astonishing increase). OPEC’s strategy then? More a short term tactic—one that does not necessitate intervention while hoping that underlying fundamentals (driven by China and others) catch up during the year.
Going Forward
Rising prices are damaging, but the United States has little, if any, control over them. A comprehensive strategy addressing U.S. oil dependence and energy is required. This must help the nation address the challenge in the short, medium and long term. It ought to include improving efficiency, transitioning the transportation sector away from petroleum, raising domestic energy production, and mitigating global threats to the energy supply chain.
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