Opec losing control over oil markets

[LRE]

Opec losing control over oil markets


RIYADH, Nov 3: Are the oil markets on the edge of a bottomless pit? Despite the lowering prices, global consumption is far from recovering, straining the markets further. And with prospects of a turnaround in global crude consumption minimal, the markets are in a continuous downward slide. Can the Opec succeed in stemming it?

In the face of the financial crisis, reversing the trend would indeed be a hard nut to crack for the oil cartel. It is indeed not easy to salvage a commodity from a free fall. And the recent Opec decision to cut output also did not seem to have any real impact.

In retrospect, over the past 10 years, Opec had made three major output cuts in 1998, 2001 and 2006 but none saw immediate price rebound. Would this time be any different? The immediate prospects seem remote.

Opec control of the oil markets is diminishing. It appears to have still less control over the crude market. Opec’s ability to channel the crude markets by adjusting the taps appears to have steadily weakened and it is in no better of the position now.

Facts speak for themselves. After all it controls less than 40 per cent of the market and non-Opec players also have a role. Russia still controls roughly 11 per cent of the market. And unless major non-Opec players also agree to work to sway the markets, it may be difficult to achieve.

Two factors outside Opec’s direct control are contributing to the precipitous decline of crude prices. One is the strengthening US dollar. As the currency increases in value, the price of a barrel will inevitably fall as oil is purchased in dollars. The second is decreasing demand as economies across the world slow.

And Opec has no control on any of these. The whipping boy that Opec has in the meantime become needs to be rested -- at least this time -- Washington and London will have to understand. The situation continues to be grim. In the immediate aftermath of the Opec decision, oil options contracts in the NYMEX to sell crude at $50 by December almost tripled as the Opec decision to slash production seemingly failed to allay concerns that the global economic slump is hurting demand.

The cost of the $50 December put option, which gives the holder the right to sell oil futures at $50 a barrel, rose last week to as much as 142 per cent to $1.50 on the New York Mercantile Exchange, compared with 62 cents the day before, according to exchange data.

On Oct 3, the $50 December put option was valued at one cent a barrel, or $10 for the 1,000-barrel lot. Speculators can profit from the rising value of put options by selling the options themselves back into the market.

Alternatively, if crude futures fall below the $50-a-barrel ‘strike’’ price, holders of the put options can exercise their right to sell futures at $50, and then buy the futures back for less in the market, making a profit.

The NYMEX options contracts are for 1,000 barrels each, as are the underlying futures contracts. And in the meantime, the price of crude has tumbled 56 per cent since rising to a record $147.27 a barrel in New York on July 11.

Many analysts think that production cut would not arrest the price fall and that demand for oil was likely to continue to fall. “It certainly seems to me that we could get down to $50 a barrel,’’ Adam Sieminski, Deutsche Bank’s chief energy economist, said. “You could look at the Opec cut as a sign of weakness, not strength,” he emphasised.

“Already we’ve seen demand destruction of two million barrels per day. I’m not convinced this cut will be enough to stop the slide,” says Rob Laughlin, at broker MF Global.

“Right now equities and the credit markets are more important than Opec,” said Rachel Ziemba, an analyst at RGE Monitor, an economic research company in New York.

“Opec won’t be able to support the oil market until other markets find a bottom and begin to recover.

“At this stage, it looks like we are at the edge of a bottomless pit and prices are heading quickly toward $50,” said Nauman Barakat, senior vice president of global energy futures at Macquarie Futures USA Inc in New York.

“Opec really needs to take the bull by the horns and make a bigger cut.

“We believe this week will mark the start of a new quota reduction cycle by Opec and it will continue through 2009,” Deutsche Bank analyst Michael Lewis said.

If prices keep falling, Opec’s Chakib Khelil said, the cartel would “definitely” reduce its production again, either when it meets in Algeria in December, or even sooner.

In view of the falling prices and Opec’s inability to stem the slide, the urgency for a producer-consumer summit level also seems to have frittered away. There are confusing signals at this moment concerning the Dec 19 meeting of the heads of state of oil producing and consuming countries, which was to be hosted by Gordon Brown as a follow-up to the Jeddah energy summit. In the medium-to-long term, this could be a recipe for disaster.

http://www.dawn.com/2008/11/04/ebr7.htm