On Tuesday, Oil Ministers from the OPEC countries gathered in Vienna to decide on production levels. It turned out one of the more remarkable meetings that OPEC has held in recent years.
Prior to the gathering, a seemingly endless parade of officials repeated the new OPEC mantra - "The oil markets are well supplied." "There is no need for a production increase at this time." "Everybody knows the subprime crisis will soon lead to a recession and the demand for oil will drop." They repeated this assertion so often and so forcefully that we all came to believe there would be no production increase.
The problem, of course, is that the world's allegedly brimming crude stockpiles have been declining rather smartly for several weeks and the International Energy Agency has been warning for months that demand would outrun supply this winter leading to shortages and higher prices. Even the normally reticent U.S. Energy Secretary warned of higher prices and economic damage unless OPEC increased production this week.
Given the fuss going on in public, one can only assume that the U.S., Europe, and every other consumer of oil - a rather long list -- was putting the pressure on OPEC -- read the Saudis -- to increase production.
In the buildup to the meeting, however, most of the rhetoric about how well the world was supplied with oil came from OPEC members such as Iran, Venezuela, Algeria and Indonesia who have little hope of increasing production in any significant way over the short term. For these countries, their national goal is to promote higher prices so they can earn more while pumping less. Prior to the meeting, the Saudis, the 800-pound gorilla of the oil world, and the only country that may have substantial capacity to produce more oil were unusually quiet.
Two days prior to the meeting, the first break in the OPEC faÃ§ade appeared when a report surfaced that, just perhaps, Riyadh and her neighbors along the Persian Gulf at last were willing to entertain a production increase.
The OPEC meeting on Tuesday went on for an unusually long time suggesting that much hard bargaining and arm twisting took place. In the end, the Saudis prevailed and organization announced that it would raise production by 500,000 barrels per day.
Now OPEC production quotas are a strange and wondrous thing. First of all, two members, Iraq and Angola, are currently exempt from them -- Angola because it is new to the organization and Iraq for obvious reasons. More interestingly, the poorer OPEC countries do not pay much attention to the quotas so when they all voted for production cuts totaling 1.7 million barrels a day last winter the actual cut turned out to be only 700,000. Some OPEC members really need the money.
When OPEC first announced it was increasing production by 500,000 barrels a day on Tuesday, it sounded a lot like a "paper increase" and not an actual one. After much confusion, OPEC spokesmen clarified that the 500,000 increase is supposed to be real oil production that will be added on top of current OPEC production, starting on November 1.
Among the more interesting consequences of the Vienna meeting was the reaction of the markets which promptly pushed oil to an all-time high close above $78 a barrel. Given that going into the meeting the expectations were for no increase, one would imagine that an additional 500,000 barrels a day would drive down prices; but it was not to happen. Oil traders had been listening to rumors of a possible 1 million barrel day increase so when the actual number came out it seemed like a mere token.
Now for the key questions: Will the 500,000 barrel a day increase actually happen? Which countries can and will increase production? Will the increase be enough to offset the 1 million barrel a day jump in demand the IEA is currently projecting for this winter?
As the increase is not supposed to start for another six weeks, it will be several months before we have much insight into what is actually happening. Most analysts believe that only the Saudis have the theoretical capacity to increase production by more than token amounts. Some are skeptical the cuts in Saudi production over the last year were entirely voluntary. Riyadh is spending a lot of money on increasing capacity, but most of this involves the reworking of oil fields and many are skeptical of how successful they will be at achieving sustainable increases in productive capacity.
This 500,000 barrel increase could turn out to be a real test of just how close Saudi oilfields are from going into decline and the real prospects for future world production.
Closer to home, the Department of Energy has released the stocks report for the week ending September 7. As this period included the Labor Day weekend, the full reduction in demand for gasoline that comes each fall will not be apparent until next week.
The bad news is that our crude oil stockpile dropped by 7.1 million barrels last week. This was probably caused by the hurricane that went through Mexico's oil fields a couple of weeks back halting production for several days. Gasoline too continued to drop, this time by another 700,000 barrels. If the decline in gasoline continues for more than a few weeks the U.S. will be getting very close to gasoline shortages even without a hurricane slamming into our oil facilities.
The good news is that the summer driving season is now over and U.S. demand for gasoline should be dropping. However, the final piece of bad news for the week is that a lot of Europe's refining capacity will be shutting down for maintenance in the next couple of months making it tougher to find gasoline to import.
By the way, the 2007 hurricane season is only half over. Currently there is yet another tropical depression deepening out in the Atlantic. By this time next week, we should know whether we will have another full-blown hurricane and just where it might hit. Given the precarious U.S. gasoline situation, all I can suggest is that you fill your gas tanks early and often.