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OPEC Production Cut Fails to Inspire Oil Market; Oil Drops to Four-Year Low

By , Money Morning •

By Jason Simpkins
Associate Editor
Money Morning

Oil prices fell again yesterday (Wednesday) – dropping below $40 for the first time in four years – as weak demand and growing inventories overshadowed a record cut in production by the Organization of Petroleum Exporting Countries (OPEC).

Light, sweet crude for January delivery fell $3.54 to settle at $40.06 a barrel on the New York Mercantile Exchange – the lowest level since 2004. Oil futures actually traded as low as $39.88 during the day yesterday. The slide came in spite of an announcement by OPEC that the cartel would cut its production quotas by 2.2 million barrels per day (bpd), a record amount.

“The Conference observed that crude volumes entering the market remain well in excess of actual demand: This is clearly demonstrated by the fact that crude stocks in OECD countries are well above their five-year average and are expected to continue to rise,” the group said in a statement. “Moreover, the impact of the grave global economic downturn has led to a destruction of demand.”

Since September, OPEC – supplier of 40% of the world’s oil – has issued three production cuts totaling 4.2 million bpd, or nearly 12% of its capacity. Still, the cartel has failed to establish a floor for oil prices, which have tumbled more than 70% from their July 11 peak of $147 a barrel. Oil has now given up all of the price gains it has made since 2004, in just the past five months.

The main reason for the decline is that the global recession has curtailed demand significantly, leaving many developed nations, as well as the cartel, with a significant buildup of inventories.

The U.S. Energy Information Agency reported yesterday that crude oil inventories increased 500,000 barrels from the previous week, while OPEC’s commercial inventories now stand at 57 days’ worth of supplies. OPEC President Chekib Khelil, said that his group wants to push inventories down to 52 days’ worth of supply and lift prices back up to $70-$80 a barrel.

However, OPEC may find it difficult to achieve those goals without help from non-OPEC nations, which balked at efforts to make a coordinated global production cut. After rumors circulated prior to the meeting that Russia and Azerbaijan might take part in the cuts, their contribution to OPEC’s effort came out flat.

“Russian oil companies have already made a decision to cut deliveries to the market… approximately equivalent to 350,000 barrels per day,” Russian Deputy Premier Igor Sechin told The Associated Press. Sechin added that the cuts had already been implemented in November.

Russia’s lack of involvement did nothing for an oil market that was crying out for a coordinated global effort. In fact, the statement came off as a thinly veiled attempt to repackage the already apparent decline in Russian oil production that has resulted from a lack of investment. 

Even before Sechin’s comments, analysts had forecast a 1% decline in Russian oil output for this year, and a 2% drop in 2009.

Azeri Energy Minister Natik Aliev said it would back OPEC’s move by cutting production by 300,000 bpd, more than a third of its total capacity. Still, analysts estimate that an accident that took place on the country’s main pumping platform in October had already cost the country 500,000 bpd in output.

“We want non-OPEC countries to contribute, and not just benefit from the impact of our cuts,” a frustrated Khelil said after the meeting in Oran, Algeria. “It’s in their own interest as well as in ours.”

A lack of foreign cooperation will put even more pressure on OPEC, and could force the group to call another “extraordinary” meeting before its next scheduled gathering, set for March 25, 2009.

"I hope we surprised you," Khelil said when asked whether the size of the cut would provide enough of a spark to ignite oil markets. "If you're not surprised we need to so something about it."

News and Related Story Links:

  • The Associated Press:
    OPEC cuts record 2.2 million barrels a day