OPEC upshot: Pricey oil here to stay

The cartel moves to cut production, which could end recent declines in petroleum prices. Is $40 a barrel the new 'floor'?

Here's a tip for Western consumers: Enjoy the recent moderation in oil prices while you can. OPEC is out to prove that it's still a king of cartels.

With the world awash in petroleum stocks, OPEC ministers last week decided that it's time they lowered production. Long term, they may want to set a higher floor under volatile oil prices, in part to protect themselves against losses caused by the declining value of the dollar.

More broadly, the cartel seems to have calculated that the higher prices won't curb global economic growth and that many industrialized countries - notably the US - aren't chafing to the point where they will institute aggressive conservation measures or dramatically reduce their dependence on Mideast oil.

As a result, the US may have entered an era in which the price of a gallon of regular gas will seldom slip much below $2. OPEC states appear intent on protecting themselves against unforeseen downturns in petroleum markets.

"There is too much supply out there right now and it's filling up inventories. And what OPEC wants to do is take some of that supply off market and raise the price," says Mark Baxter, director of the Maguire Energy Institute at Southern Methodist University in Dallas.

If you think that oil and gas prices still seem a lot higher than they used to be, you're right - as long as you're looking at a context larger than a few months.

Oil hit a record of $55 a barrel in October. Since then it has slumped to around $40, with OPEC producing crude at its highest rate in 25 years.

That relief is welcome, but relative. Even at $40, oil prices remain around 30 percent higher than they were at the beginning of the year.

And prices may rise again soon. Last Friday, OPEC ministers agreed to cut daily oil production by one million barrels, beginning Jan. 1. They'll meet again on Jan. 30 to discuss possible further cuts.

It's also possible that this reduction will simply stabilize prices, preventing a return to last year's levels.

"This is a preventative measure. It is enough to sharpen the market," said Algerian Energy Minster Chakib Khelil, following the Cairo meetings.

Perhaps the main reason that OPEC moved now is the rapidity with which prices have been sinking. Much of this fall's decline has occurred in the past two weeks.

Thus ministers may simply be exercising caution. They undoubtedly remember the 1998 Asian financial crisis, which sent prices into free-fall.

"Nobody thinks that is going to happen today, but they want to stay ahead of the market," says Rick Mueller, a senior oil analyst at Energy Security Analysis, Inc., in Wakefield, Mass.

Of course, it remains to be seen whether the scheduled drop in production actually occurs. OPEC is a fractious group in the best of times. When prices are going down, it can be every oil-pumping nation for itself.

Under last week's agreement, Saudi Arabia and six other of OPEC's 11 members are supposed to cut back production by one million barrels a day, starting Jan. 1.

Saudi Arabia is supposed to absorb half of the reduction. But the nature of the cartel's coherence can be seen in the fact that the new cut, if fully implemented, will lower OPEC's total output to 27 million barrels per day - a figure which is already its official target.

"Its going to test the cohesiveness of OPEC.... It's easy to act together when prices are high. But when prices begin to drop, countries say 'We've got our own national interest to protect,' " says Robert Ebel, chairman of the Energy Program at the Center for Strategic and International Studies in Washington.

Overall, last week's decision is unlikely to damage the American economy, says Ebel. More expensive petroleum would hurt, but not too much.

"[The US] economy can absorb that. A half a percent decline in GDP is not so bad," says Ebel. "But for the developing countries of the world, it's really going to hurt."

Long term, however, world economic trends might rule out a return to the relatively cheap gas and oil of even a year ago. For one thing, world demand is heating up, as China and other East Asian nations gobble resources to fuel their economic boom. For another, the decline of the dollar relative to the Euro and other major currencies costs OPEC money, because its oil is priced in dollars. Keeping prices higher helps compensate for this slide.

This is why some OPEC members, such as Iran and Libya, are pushing to raise the price that the cartel considers a floor for its commodity.

Currently this benchmark price is $22 to $28 a barrel. The price hawks want to push it up to $35 to $40 a barrel.

Considering that oil today is trading around that higher price, it might seem like this decision has already been made. But oil ministers said that is not so, and insisted that for now, they are trying to protect themselves against a buildup of oil inventories due to unseasonably mild weather in the northern US, among other things.

OPEC's future course might be clearer following its scheduled Jan. 30 meeting. If nothing else, the course of the American winter should be clear by then.

"A cold snap would affect heating oil stock and support crude prices," says Rick Mueller of Energy Security Analysis.

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