OPEC Agrees to Record Output Cut to Combat Falling Oil Prices

Light, sweet crude for January delivery fell more than 5 percent, or $2.21, to $41.39 on the New York Mercantile Exchange. Benchmark crude prices fell as low as $40.20, a price last seen in the summer of 2004, on skepticism that OPEC will be able to carry out its promise to reduce surplus and amid continued concerns over the state of the global economic crisis.

The move by OPEC, which accounts for the production of 40 percent of the world’s oil, is an effort to combat the precipitous slide of oil prices, down 70 percent since peaking five months ago.

With the economy in a downturn, taking oil consumption with it, oil stockpiles have climbed 11 percent since Sept. 19, Bloomberg News reported. The U.S. Energy Department said Wednesday supplies climbed for the 11th time in 12 weeks.

U.S. gasoline inventories also continued to rise, government data show, providing fresh evidence of a major pullback by American motorists, the Associated Press reported.

The OPEC announcement is the third output cut in recent months. Since September, OPEC has pledged cuts totaling nearly 12 percent of its production capacity, a record decrease over such a short time, the New York Times reported.

The group is asking non-OPEC countries to do their part to rebound prices by voluntarily cutting their production as well.

“We want non-OPEC countries to contribute, and not just benefit from the impact of our cuts,” Chakib Khelil, OPEC’s current president said during Wednesday’s news conference. “It’s in their own interest as well as in ours.”
But many experts remain unconvinced.

“The OPEC announcement looks big on first glance but really isn’t. They are playing with smoke and mirrors,” Nauman Barakat, senior vice president of global energy futures at Macquarie Futures USA Inc. in New York told Bloomberg.

Others questioned OPEC’s ability to follow through with the output cut.

“OPEC has lacked credibility for a long time on discipline,” Gerard Rigby, energy analyst at Fuel First Consulting in Sydney, told the AP. “OPEC is going to have to show they are committed to the cut, that it’s not just talk.”

World inventories of crude have grown to a 57 days’ supply and OPEC is hoping for a return to a 52-day level to stabilize prices. Steven Mufson of the Washington Post wrote that that plan could work, but that it is possible oil prices could stay low despite the production cut.

“One theory about international oil prices suggests that the price is more sensitive to the amount of excess production capacity rather than to the amount of oil in inventory,” Mufson wrote.

OPEC also risks exacerbating the economic slide, according to Harry Tchilinguirian, an oil analyst at BNP Paribas.

“OPEC appears to be caught in a ‘Catch-22’ situation,” he wrote in a report quoted by the New York Times. “An attempt to aggressively boost prices, by pursuing a larger-than-expected cut, could backfire by turning sentiment even more pessimistic on the economy.”

Part of the problem oil producers are facing is that their future budgets are based on oil prices well above the $50 a barrel level. With no end to the economic strife in sight, conditions could get worse for oil producers as more companies are forced to make layoffs and cut back in the New Year.

“There is a sense of more bad news after Christmas, in more layoffs that businesses were not going to talk about until the holidays were over. We could have a miserable first 100 days of 2009 and that could hurt demand for oil and gasoline even more,” Tom Kloza, chief oil analyst for the Oil Price Information Service in New Jersey told the Los Angeles Times.

As the outlook stands now, world oil consumption is projected to be lower this year than last year, the first time oil demand has dropped in 25 years, according to a forecast by the International Energy Agency.

“You’ve got a commodity that people are buying less of because they can’t afford to buy more,” Phil Flynn, an analyst at Alaron Trading Corp, told the AP. “People are fearful. They have a lack of confidence in the economy. They’re closing their factories.”