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Oil prices may drop substantially this winter

After hours of debate and persuasive suggestions by the US the OPEC agrees to a 500,000-barrels-per-day increase in production from November, reports DH Pai Panandikar.

india Updated: Sep 14, 2007 22:00 IST

On the 11th of this month the Organisation of Petroleum Exporting Countries (OPEC) met in Vienna against the background of a tight oil market. After seven hours of debate and persuasive suggestions by the US the OPEC agreed to a 500,000-barrels-per-day increase in production from November. The next day prices jumped to a new peak of $80 per barrel.

In the past one year oil prices have shot up 29 per cent. A part of the increase in price was due to the fall in the value of the dollar. However, even in euros, the price of oil rose 18 per cent. Since the rupee appreciated more than the euro the price of oil in rupees was 12.5 per cent higher. A barrel of oil cost Rs 2,868 last September; now it costs Rs 3,227. The rupee is not likely to appreciate any more against the dollar and further increases in the dollar price of oil will be fully reflected in our oil imports.

Although OPEC is an oil cartel, its control on the members is not too strong. Iraq and Angola have the freedom to export as much oil as they like or can. But there is infringement of commitments from other members. A fall in production can be because of obstructions such as strikes, as it happened in Nigeria. But there is also a breach of quotas from members to earn larger revenue. In August, 10 members, excluding Iraq and Angola, pumped about 27 mbd (million barrels a day), 1.1 mbd more than the agreed quotas. In spite of that prices stayed high.

Whether prices will rise or fall in future will depend upon the state of demand. Last month, the International Energy Agency had estimated world demand this winter at 88.1 mbd, about 1 mbd more than the expectations of OPEC.

Production by OPEC members is about 40 per cent of world production and 70 per cent of world exports. With the additional production agreed to this week, the oil market should have eased. But prices actually rose.

OPEC does not decide prices. Yet, a price drop below $70 a barrel is bound to be resisted by some OPEC members. At their last meeting, Saudi Arabia was able to convince other members about the need to increase production because the current tight market could have taken the price to $80 a barrel and caused a slowdown in the world economy.

Looking at the divergent views, it appears that oil prices are likely to move in the $70 to $80 range per barrel. The ceiling has already been breached.

The market however may not remain tight for long. The sub-prime crisis has cast a shadow on economic growth in the US. In August, for the first time in 4 years, employment declined. That is an indication that there is a chance that the US economy may run into recession or at least slow down. If that happens world demand for oil will decline. It is therefore possible that, in winter, prices of oil will fall precipitously.

The writer is president, RPG Foundation.