OPEC Makes a High-Stakes Bet

Gambling that a small cut in production will stabilize prices

It was an unprecedented action by the Organization of Petroleum Exporting Countries. It might also prove too timid to achieve its goal.

With a worldwide oil glut estimated to exceed 5 billion bbl. of crude, OPEC is making its first attempt ever to firm up prices by reducing production. But the 13 members voted to curtail output by only 9.6%, or some 700,000 bbl. per day.

Oil markets were not giving any clear indication last week about whether the cut would firm up prices. The cost of competing North Sea oil on the spot market slid a few cents a barrel, to about $28, approximately the same level as the week before. Oil experts say that it may be several months before the effects of the OPEC cuts can be fully evaluated.

Though the size of the reduction is modest, industry experts were impressed by the sheer fact that the fiercely nationalistic and independent-minded oil producers had agreed to any sort of production quotas. "Now you can call us a real cartel," crowed one senior OPEC staffer, after agreement was reached two weeks ago in Vienna. "What matters is not the production target alone, but the fact that we have set one, and announced it for the first time."

In the deal, OPEC's total daily output is expected to drop from the early March level of 18.2 million bbl. to 17.5 million bbl. Some 500,000 bbl. of the cut will be sustained by Saudi Arabia, the cartel's largest single producer, with the remaining 200,000 bbl. being spread among other members. The group agreed to review its pricing and production arrangements in several weeks, when the organization's members gather for a previously scheduled spring conference in Quito, Ecuador. Said OPEC President Mani Said al-Oteiba of the United Arab Emirates: "If need be, we are ready to cut production to zero, and OPEC as a whole is prepared to cut back to 10 million barrels."

Whether OPEC's price-propping ploy succeeds will depend on the willingness of members to abide by the agreement. In the past two years, weakening worldwide demand for oil has driven down the spot-market prices for crude until they were about $6 per bbl. below the official OPEC benchmark price of $34 per bbl. If prices continue to slide, cash-hungry producers such as Algeria, Venezuela and Nigeria will be tempted to offer under-the-table deals to potential customers in order to take sales away from other cartel producers. To monitor compliance, OPEC decided to set up an oversight committee that will keep tabs on weekly production figures of all members.

One OPEC state that is already selling oil at a discount is Iran. The Tehran government's prices range from $30 to $32 per bbl., but the revolution-racked regime is having difficulty producing enough oil to export. Before the fall of the Shah in 1979, Iran was the second largest producer in OPEC after Saudi Arabia.

The Saudis, though, seem determined to make the production cut work. Petroleum Minister Sheik Ahmed Zaki Yamani threatened that the desert kingdom would further reduce output in the months ahead if necessary to keep the market tight. He also issued thinly veiled warnings to other OPEC producers not to cheat on the Vienna agreement because doing so would avail them nothing.

A key factor determining the future course of oil prices will be the state of Western economies. Demand for oil is naturally less when business is slow and factories are idle. The deep U.S. recession and conservation efforts have driven American demand for petroleum products down by 6% in the past twelve months alone, to 15.9 million bbl. per day.

Many economists expect the U.S. economy to begin growing, albeit slowly, later this spring or summer. Business in Europe and Asia will probably pick up shortly thereafter. Industry experts predict that world petroleum stockpiles, which now bulge with 105 days of supply, will dwindle to a more normal 90 days by year's end, once demand for crude increases. If so, OPEC may again find itself dealing in oil markets from a position of strength. Today's declining prices for gasoline and heating oil would then become just a fond, fading memory.

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