OPEC's spare capacity could fall short

cbs.marketwatch.com By Myra P. Saefong, CBS.MarketWatch.com Last Update: 3:57 AM ET Jan. 11, 2003

VIENNA, Austria (CBS.MW) -- The Organization of Petroleum Exporting Countries will likely agree to boost production at an emergency meeting this Sunday but with little spare capacity, the cartel's decision might not carry much weight if the market loses Iraqi oil, analysts say.

"Spare capacity is not sufficient to offset losses from Iraq and Venezuela," said Thorsten Fischer, an energy economist at Economy.com.

OPEC's untapped output, excluding OPEC members Venezuela and Iraq, is 2.7 million barrels per day, he said. Output from Iraq totals 2.4 million barrels per day and Venezuela's pre-strike output was at around 2.9 million barrels per day.

So in the event of a U.S. war with Iraq and a disruption of oil exports out of the country, the market could lose a total of more than 5 million barrels a day -- only half of which can be made up by other OPEC oil producers, according to Fischer.

The total amount lost would represent about 6 percent of the world's oil demand of 78 million barrels a day.

OPEC agreed earlier in the week to hold the special meeting just a month after members decided to raise their production quota to 23 million barrels a day from 21.7 million, in an effort to lower actual production, which was running well above 24 million. See related story.

But, if OPEC uses 1.5 million barrels per day of spare capacity to make up for Venezuela, "there won't be much available to make up for any loss from Iraq," said Todd Hultman, president of DailyFutures.com, a commodity information provider.

The cartel doesn't expect to implement an output hike until at Feb. 1 and has said it would cancel the move if Venezuela's situation were resolved.

And since shipments take at least five weeks to arrive in the U.S., "there would not be any actual relief in the U.S. until sometime in March," Hultman said.

Output hike range

With that in mind, analysts predict that a number of factors will affect the size of OPEC's ultimate output increase.

Saudi Arabia, the OPEC member with the largest spare capacity -- around 2 million barrels per day -- backs an output hike of around 1.5 million to 2 million barrels. If OPEC uses 1.5 million barrels per day of spare capacity to make up for Venezuela, "there won't be much available to make up for any loss from Iraq."

Todd Hultman, president of Dailyfutures.com     

"OPEC member states currently operating at or near capacity are less likely to vote for a production increase, while Saudi Arabia is more likely to lobby for a more aggressive hike in OPEC's official quota," said Michael Armbruster, an analyst at brokerage house Altavest Worldwide Trading.

The latest data on U.S. supplies failed to reflect much of an impact from the Venezuelan strike, with the U.S. Energy Department even reporting that crude supplies rose by 400,000 barrels during the week ended Jan. 3. The data may tilt oil producers toward favoring a smaller hike. See full story.

Then there's OPEC's price band agreement to consider, said Fischer. It's not clear where that fits into the picture, given that OPEC's start date for its probable output hike isn't until Feb. 1.

The cartel's basket price, or the average price of seven types of crude oil, has been above $28 a barrel for 18 days as of Friday, according to Dow Jones.

OPEC's agreement calls for the addition of 500,000 barrels per day if the price holds above $28 for more than 20 days, making Tuesday the trigger date for a hike.

Quick Iraqi war scenario "Oil prices will likely rise in the run up to a war with Iraq, despite OPEC's commitment to increase production, which will at best dampen price increases."

Thorsten Fischer, economist at Economy.com     

Another scenario to consider: following a successful U.S. and allied attack on Iraq, there's a chance the oil market will see prices collapse and supplies overflow -- a prospect that could scare OPEC into increasing quotas by "substantially less than the 2 million barrels advocated by Saudi Arabia," said Fischer.

Still, it's doubtful any U.S. attack on Iraq will occur before Venezuela is on its way to restore production close to pre-strike levels, he said.

"The strike in Venezuela and the Jan. 27 deadline for weapons inspectors now seem to suggest that the U.S. will strike at the earliest in February," he said.

On Jan. 27, Chief U.N. weapons inspector Hans Blix will provide a detailed assessment of Iraq's compliance with the weapons inspections that began just before Thanksgiving.

"Oil prices will likely rise in the run-up to a war with Iraq, despite OPEC's commitment to increase production, which will at best dampen price increases," Fischer said.

He expects prices to average around $35 per barrel during the first quarter, with prices "substantially" higher ahead of a war and well below that after a successful attack.

Once the war has ended and Iraqi President Saddam Hussein is removed from power, "Iraqi production should increase considerably from current levels," said EnergyTrendAlert.com chief trading strategist, Grady Garrett.

"The speed of Saddam's departure is crucial to getting oil prices down in any meaningful way," he said.

Reserves to the rescue

For now, with the cartel's production hike likely to fall short, the only safety for the U.S., which consumes around 20 million barrels per day, is its Strategic Petroleum Reserve. "The Strategic Petroleum Reserve remains the only source of crude oil that would be available on short notice to consumers in the U.S." Thorsten Fischer      "The Strategic Petroleum Reserve remains the only source of crude oil that would be available on short notice to consumers in the U.S.," said Fischer.

Hultman pointed out that with OPEC showing its willingness to help out at its meeting Sunday, "it would not be unreasonable to expect the president [will] release crude supplies to coincide with an attack on Iraq."

At 600 million barrels, the reserve is currently near its full capacity.

But, President Bush won't likely release the reserve oil immediately upon the outbreak of a war with Iraq, said John Person, head financial analyst at Infinity Brokerage Services.

And it's probably best that he doesn't, Person said, emphasizing that the oil could be of more use in the event that Hussein decides to sabotage his country's oilfields and blame the U.S., and supplies are disrupted from other Arab nations.

"There are lots of doom and gloom prospects out there," he said.

Overall, however, major industrialized countries have the ability to release around 12.9 million barrels per day from reserve stocks for a month, with that amount falling to 9 million barrels per day in the second month, Person said, citing data from the West's energy watchdog, the International Energy Agency.

OPEC fears these stockpiles could be released once members increase production and start shipping more crude, he said. That would cause prices to fall below their ultimate target price of about $25 a barrel.

"The meeting will be a debate to find the balance between increased production and the ramifications on prices if the government stockpiles are released." John Person, head financial analyst at Infinity Brokerage Services      With those concerns, OPEC may decide on a more modest increase in supplies, on the order of 1 million to 1.5 million barrels per day, said Person. Little spare capacity would put a damper on any cheating, he added.

"The meeting will be a debate to find the balance between increased production and the ramifications on prices if the government stockpiles are released," he said.

Then again, said Dailyfutures.com's Hultman, all these concerns could end in just the "twinkle of an eye" if Venezuela's military switches sides, ending the strike and Iraq's Hussein suddenly flees the country.

"Venezuela and Iraq could be back in the oil business and the crude problem would be over," he said. "That is often how these things go."

Myra P. Saefong is a reporter for CBS.MarketWatch.com in San Francisco.