Will OPEC's Gambit Drive Oil Prices Higher?

Will OPEC's Gambit Drive Oil Prices Higher?
Will OPEC's Gambit Drive Oil Prices Higher?

Saudi Arabian Oil Minister Ali al-Naimi said his country cut oil production by 800,000 barrels a day in March, dropping its output to 8.292 million bpd for the month. He also said the market was "oversupplied," according to Bloomberg. This move came despite Saudi claims that it would make up for lost production in Libya. Experts have expressed concerns that supply may be further reduced by political turmoil in Northern Africa, the Middle East, and Nigeria.

Crude prices are already at levels that threaten the global economic recovery, according to some experts. WTI crude is near $110 a barrel, and Brent is near $123 a barrel. Prices have been rising for several months and the increase does not appear to be slowing.

The Saudis' choice to cut production raises the question of what kind of gambit OPEC is attempting. Certainly these comments from Saudi Arabia, OPEC's largest member by production, have a reasonable chance of raising crude prices. If the comments are supported by other OPEC members, the move is almost certain to do so.

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OPEC nations could have two goals for indicating their intention to reduce crude exports. The first is the most obvious: They want to capitalize on the political and market instability to push oil prices higher, thus putting more money into their national treasuries. If that's their motivation, it's not without risk. Widespread economic reversals in many nations -- brought on by increased energy prices, among other things -- would almost certainly cause a drop in the demand for oil. OPEC might get a short-term gain in profits, followed by a longer-term erosion in demand.

The other possible motivation of OPEC nations to suggest that the global supply of oil is sufficient is that they genuinely believe it is. Under such circumstances, the cartel could actually hope to bring down crude prices to sustainable levels by showing that the current high prices are due to investor speculation and not economic fundamentals. Crude will sell off soon, they would argue, if the markets are convinced that OPEC comments are based on the truth.

The economies of the developed nations and other countries such as China, the largest net importer of oil, will run out of steam if oil prices stay at these high levels. Energy prices will eventually erode consumer activity and businesses' profit margins: It's hard to make a case that that would be good for global GDP.

Whichever motivation is OPEC's true one, the cartel's latest effort has a real chance of pushing oil prices even higher.

Originally published