OPEC will struggle to hold runaway oil price

businessresources.smh.com.au By Alex Lawler March 8 2003

OPEC, which pumps a third of the world's oil, may struggle to lower prices from among the highest levels in 12 years as the threat of war with Iraq builds and members near their limit for output.

Ministers meeting in Vienna on Tuesday would probably approve a plan backed by Saudi Arabia to pump as much oil as possible should a war disrupt supply from Iraq, the third-largest Middle East producer, officials and analysts said.

Oil prices last week reached the highest since Iraq invaded Kuwait in 1990 and touched $US39.99 a barrel in New York, raising fuel costs and threatening to stunt economic growth. Only Saudi Arabia and the United Arab Emirates have the capacity to refill US inventories, which set a 28-year low last month.

"There isn't enough OPEC capacity to cover the loss of Iraq," said Leo Drollas, deputy executive director of the Centre for Global Energy Studies in London. "We're entering a probable war with low inventory cover. Prices could go higher still as the war drums beat louder."

Ten OPEC countries set oil-output quotas as a way to control oil prices and supply, and member Iraq has no quota because its sales are under United Nations oversight. The group raised quotas in January and February after exports from Venezuela were crimped by a strike and a colder-than-normal winter raised demand.

Oil ministers will set policy for the second quarter as analysts expect any US-led attack on Iraq, source of 2.5 million barrels a day or 3 per cent of the world's oil, to take place within weeks. Oil demand normally declines after the first quarter because of the northern hemisphere spring.

Indonesia oil minister Purnomo Yusgiantoro said OPEC should keep quotas unchanged until the group knows the result of the stand-off between the US and Iraq. Saudi Arabia, the United Arab Emirates and Kuwait wanted to raise quotas, he said.

Whether OPEC suspends restraints or not, members are ignoring them. In February, all nations exceeded their output quota except Indonesia and Venezuela, members unable to pump more.

"They already have an informal understanding that everybody should produce as much as they can," said Adam Sieminski, an oil strategist at Deustche Bank. "Probably the best decision that OPEC could make is steady as she goes."

OPEC's oil production rose 6.3 per cent in February, the biggest monthly increase in four years, as output in Venezuela rebounded after the two-month strike and other nations pumped more, a Bloomberg News survey this week showed.

Analysts put OPEC's spare capacity at about 2 million barrels a day, less than Iraq's daily output. Two million barrels is enough to meet daily demand in France, the world's fifth-largest economy. The situation would worsen should Kuwait close oil fields in the event of war. Kuwait, OPEC's sixth-largest producer in February, said this week it would close all northern oil fields if the US attacks neighbouring Iraq to avert damage. The fields produce about 500,000 barrels a day.

Prices might not drop until additional oil from Saudi Arabia reaches consumers and the situation over Iraq becomes clearer, analysts said. Saudi Arabia was already producing about 9 million barrels a day, they said.

"The Saudis have dramatically increased their production," Mr Sieminski said. "That oil should be hitting the markets over the next few weeks, and assuming that things don't go badly in Iraq, we should begin to see inventories building. That should bring prices down."

Executives at companies including BP and Royal Dutch/Shell Group have said they expect a jump in oil prices should the US proceed with an attack on Iraq. Prices in London rallied to $US40.95 during the invasion of Kuwait, and sank to $US16 as the ejection of Iraqi troops neared.

The US and other importing countries hold inventories to alleviate shortages, which may have to be tapped should an attack disrupt Middle East shipments, analysts said.

Bloomberg