Making Oil a Scarcer Commodity

By Stephen Koepp

To shore up sagging prices, OPEC aims to cut output

"OPEC never was a cartel, and it is less so now. I wish it were a cartel, because we would have much stronger enforcement of the rules."

Those words by Subroto, the Indonesian Oil Minister and the current president of the Organization of Petroleum Exporting Countries, show how the once mighty oil group has fallen. Only a few years ago, whenever OPEC met, the world anxiously waited in fear that the petroleum producers were about to raise oil prices again. But last week at an emergency meeting in Geneva, OPEC struggled to avoid slashing prices once more. Rather than reduce the cost of crude, the ministers adopted a plan to reduce temporarily their production ceiling from 17.5 million bbl. per day to 16 million bbl.

The latest OPEC crisis was set off three weeks ago, when Norway discounted its oil price by $1.50 per bbl., to $28.50, because it could not sell all it wanted to at the higher level. Britain quickly followed, and then Nigeria, an OPEC member, broke ranks with the cartel and lowered its price. OPEC members, fearful of a round of reductions, scrambled to halt the slide.

Sitting in plush green armchairs in the ballroom of Geneva's Inter-Continental Hotel, the ministers last week quickly agreed to cut production. But then they wrangled for 2% days over how to divide up the cutback. That renewed oil industry doubts about OPEC's ability to live up to its decrees. During a cordial but "extremely frank" meeting, as one participant described it, ministers from Iran, Venezuela and Algeria lambasted their Nigerian colleague for helping to set off the crisis. Citing Nigeria's dire economic woes, Oil Minister Tarn David-West rebuffed pressure to restore his country's petroleum price or to cut its production target "by even one barrel." Said he: "Oil is the life of Nigeria. The Nigerian heart must pump."

Saudi Arabia, OPEC's biggest producer, took the brunt of the group's 1.5 million bbl.-per-day cutback. The Saudis agreed to reduce their output limit by 647,000 bbl. a day, to 4.4 million bbl. More important, Sheik Ahmed Zaki Yamani, the Saudi Oil Minister, promised to trim production even further, if necessary, to hold the line on prices. Other OPEC members, except Nigeria and Iraq, grudgingly accepted reductions of about 9% each. Two non-OPEC oil producers, Egypt and Mexico, whose petroleum ministers attended some of last week's sessions as observers, promised to help the OPEC effort by making small, symbolic cutbacks of their own. Sheik Saad al-Abdullah al-Sabah, Kuwait's Prime Minister, praised the accord as a show of unity. Said he: "I have no doubt that by agreeing on this sensitive issue, OPEC members will restore the organization's strength and widely heard voice."

OPEC's decision initially had a mixed effect on world oil markets. Prices edged upward slightly in the futures market, where contracts are traded for delivery months in advance. But OPEC's pronouncement did not prevent several U.S. oil companies from lowering the price they would pay for crude by about $1 per bbl. The oil industry experts who were unimpressed by OPEC's fanfare claimed that the reduction was meaningless because the group is already producing only about 16 million bbl. per day, less than the production limits agreed to last week.

The oil ministers, however, contended that the new limits will put strong upward pressure on prices as early as mid-November, when winter demand for heating fuel is expected to push the need for OPEC crude to at least 18.5 million bbl. a day.

Yamani boasted that the tactic could quickly mop up the global oversupply of crude. Said he: "We think the reaction will be felt in the market the minute buyers try to find a barrel and cannot get it easily." In the event that OPEC'S strategy starts to cause shortages, said Yamani, the Saudis may produce more in order to meet demand.

The biggest threat to OPEC's strategy is the tendency of its members to cheat on their quotas, which renders ineffective any attempts to limit global supply. The group first imposed quotas in March 1983, along with OPEC's only price cut in history, a markdown of its benchmark Arab Light crude by $5 per bbl., to $29. Most members' output currently falls below their quotas, but that is largely because they cannot find enough buyers. As soon as winter demand for oil increases, OPEC members who have exceeded pumping limits in the past will be tempted to break the new one as well. Mani Said al-Oteiba of the United Arab Emirates, an Oil Minister who sometimes writes long poems about the OPEC meetings, last week warned of the problem. His verse: "Do not ask me to mention any name/ You know all the secrets and whom to blame."

Though OPEC has no real way to enforce compliance, the current crisis may bring about honesty in the group. Said Indonesia's Subroto: "We will need much tighter supervision than before about members' living up to their commitments, because everything depends on that."

The OPEC ministers put off until December any decision about their thorniest problem, an imbalance in prices between the two major types of oil. Traditionally, refiners have paid a premium for light, low-sulfur crude, which is used primarily to produce gasoline. But because of improvements in refining technology, buyers now prefer the less expensive heavy oil.

This has created a surplus of the lighter fuel produced by Britain, Norway and Nigeria. To boost sagging sales, those countries want OPEC to reduce the price of light oil in relation to heavy. Last week Mani Said al-Oteiba, whose country is a leading light crude producer, threatened to force the issue by slashing his country's price. Said he: "If there isn't a solution, I will solve it myself when I go back home." The Oil Minister later agreed to hold off on the discount.

World oil markets, rather than the promises made in Geneva, will determine whether last week's agreement will work.

The ministers succeeded in their initial goal to prop up oil prices in short-term trading. Now they hope that their production cuts will lock in those gains when winter oil demand increases. OPEC is gambling that the market will turn its way.

The next few weeks will show whether it wins that bet.

--By Stephen Koepp. Reported by Lawrence Malkin/Geneva

With reporting by Lawrence Malkin/Geneva