Wednesday, October 29, 2008

Oil prices closes down despite OPEC talk about further cuts

Oil prices ended trading Tuesday below $63 US as traders disregarded OPEC's 1.5-million-barrel production cut and talk about further reductions.

A barrel of crude for December delivery finished the trading session at $62.73, a drop of 49 cents compared to the value at the end of trading Monday.

Oil prices traded as high as $65.20 on Tuesday.

Oil watchers essentially ignored the decision of the Organization of Petroleum Exporting Countries on Friday to cut production by 1.5 million barrels a day.

OPEC members currently pump out 28.808 million barrels each day to satisfy global demand. Economies in the industrialized world, however, were slowing even before September's global financial crisis, crimping interest in petroleum.

Oil prices, which peaked at $147.27 US a barrel on July 11, have fallen sharply since then.

Worse still, economic sentiment now points to a recession, a factor weighing on future oil prices.

Experts miss the mark

Many experts originally predicted OPEC would cut production at the $80 level to maintain government revenue among its members. As a result, industry watchers expected a cut in the range of one million barrels, an unusually deep reduction.

As it turned out, OPEC chopped output by 50 per cent more than analysts had anticipated as the once-powerful oil cartel is now staring at its own blended reference price of $56.80 US a barrel.

Some analysts have questioned the effectiveness of these types of cuts.

Some OPEC countries have often been accused of pumping out more oil than their quotas allowed, rendering production cuts less potent.

The problem is especially prevalent among members such as Nigeria, which have large populations and need a continual source of government revenue to fund infrastructure and social programs.

"Since most oil-exporting countries rely heavily on oil revenues for public finance, in the wake of lower oil prices, one would expect a country to exceed its quota to compensate for failing oil revenues," said economists Sel Dibooglu and Salim AlGudhea in a 2007 paper on OPEC cheating.

OPEC cannot control the extra sale of oil, because it cannot keep its members in line, Dibooglu, an economics professor at the University of Missouri-St. Louis, said in an interview.

"For OPEC’s 1.5 million cut to be effective, it has to have a good enforcement mechanism, and OPEC does not have any," he said from his St. Louis, Mo., office.

"It is said that Saudi Arabia acts as an enforcer by punishing countries which overproduce their quota. We found that Saudi Arabia acts forcefully only when other countries cheat substantially. For small cheating, Saudi Arabia does not find it worthwhile to act."

Even as the first reduction was seeping into the oil market, OPEC said it would meet in December to consider further production cuts.



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