Mr Alizadeh is Senior Oil Market Analyst at the Iranian Ministry of Petroleum of Iran (balizadeh@nioc.ir). This analysis is based upon the personal opinion of the author and does not represent the official view of the ministry.

OPEC, at its 160^th meeting of conference on 14 December 2011 held in Vienna, Austria, decided to set its production at 30mn b/d from the beginning of 2012. The OPEC press release emphasized that the agreed amount will include the production of Libya now and in future and includes Iraq oil production as well. 

According to the latest secondary sources data published by OPEC in January, OPEC production in December 2011 reached 30.822mn b/d.¹  The data shows that Libya’s crude oil production reached 773,000 b/d in December.²  It is important to note that after the OPEC meeting, Libyan Minister of Oil and Gas 'Abd al-Rahman Ben Yezza announced that Libya’s oil output had hit 1mn b/d.³  He said that his country’s crude oil would reach 1.3mn b/d by the first quarter and 1.5mn b/d by the second quarter of 2012. It means that until the next formal meeting of OPEC, which is scheduled to be held on 14 June 2012, Libya’s oil production will be almost doubled compared with December 2011. 

So, if other OPEC members are to observe the 30mn b/d ceiling of the organization, they have to decrease their production about 1 mn b/d in January 2012 and gradually shrink their production more by about 1.5mn b/d by the end of the first half of 2012 to pave the way for Libya’s coming back. 

Meanwhile, there is also OPEC member Iraq that is trying to increase its production. According to the secondary sources, Iraq’s oil production in December 2011 was at the level of 2.723mn b/d. The country’s Minister of Oil 'Abd al-Karim al-Laibi has announced that Iraq’s crude oil production will increase to 3.4mn b/d in 2012.⁴  In other words, Iraqi production will increase by 700,000 b/d in 2012.

It is worth knowing that although the new agreement includes Iraqi crude oil production, the country is still out of the OPEC quota system and what was agreed at the meeting does not mean a readmission of Iraq into the quota system. Therefore, it will be very hard for the oil marketto believe that Iraq will postpone its production increases until the second halfof 2012 since the financial needs of this country for reconstruction is too obvious. 

Since the individual quotas and the mechanism for correcting the production were not determined in the meeting, regarding what is mentioned above, one may ask, who is going to decrease production and how to make way for Libya and Iraq to increase their production?

Table1: OPEC Crude Oil Production Based On Secondary Sources ('000 B/D)

Source: OPEC Monthly Oil Market Report, April 2011 and January 2012. 

Although the official OPEC statement has not addressed this issue, the first answer to the question is that those members which have increased their production to compensate for the Libyan crude oil shortage should also reduce their production. 

To identify these members, crude oil production of the OPEC members for the two months of January 2011 (when Libyan production was normal) and December 2011(when OPEC held its 160^th meeting of the conference) is compared in Table 1. 

As can be seen in this table, Saudi Arabia increased its production by 1.104 mn b/d and is at the top of the list. Kuwait, increasing by 368,000 b/d, is in second place, followed by the UAE and Angola, respectively, increasing by 205,000 b/d and 135,000 b/d. Venezuela and Ecuador also have increased their production respectively by 38,000 b/d and 12,000 b/d. 

But, after the meeting, Saudi Minister of Petroleum and Mineral Resources Ali Naimi said: “If Libya increases, it doesn’t necessarily mean Saudi will cut. We don’t react to that, we react to market demand.” ⁵ 

So, it cannot be expected for certain that Saudi Arabia, which gained the most benefits, will cut its production as Libya returns to the market. It is the overall market conditions that will determine whether Saudi Arabia will reduce its production or not. Therefore it can hardly be expected that other members of the organization who were on the list will reduce their production simply because of Libya’s return to the market. 

Now that the quota system – which was used for the last time in the 141^st OPEC extraordinary meeting in Caracas, Venezuela, on 1 June 2006 – has long been suspended and the agreed production target of 24.845mn b/d that was approved in 151^st OPEC extraordinary meeting in Oran, Algeria, on 17 December 2008 has been abandoned, the question may be asked about what will happen in the absence of an OPEC production control mechanism. 

To answer the question it is necessary to classify what will happen in the short term in two scenarios according to main assumptions:

First Scenario: Decoupling The Fundamentals And Prices Assumption

The 160^th OPEC meeting was held at a time when nominal crude oil prices were at a very high level and the OPEC Basket price was at $106.88/B. Even the average of the OPEC Basket price in 2011 (from the beginning of the year to 9 December 2011) reached $107.53/B, which was unprecedented in recent oil history. Undoubtedly, at this level of prices it could not be expected that oil producing countries reduce their production. So the OPEC meeting was held in such an atmosphere that it was rational for the members to send as much of their crude oil to the market as prices dictated.

If we accept the assumption that geopolitical concerns, developments in financial markets, speculation and unwritten agreements have cut the link between market fundamentals and oil prices, it will be the best opportunity for OPEC members to produce as much as possible and maximize their oil revenues. In particular, it is very well known that oil revenues are vital for most OPEC members to enable them to pursue their development programs. 

The above-mentioned assumption means OPEC does not have to engage itself in the issue of quota setting. So the best decision was using the most familiar tools, ie supply and demand, to reach a general agreement on the production ceiling to assure the market that OPEC will do its best to balance the market.

A review of global oil supply and demand presented by OPEC in its Monthly Oil Market Report of January 2012 shows that demand for OPEC oil in 2012 will be about 30mn b/d (Table 2). Therefore the best decision is that OPEC production be set at 30mn b/d as it was decided at the 160^th OPEC meeting. And if in spite of the high volume of excess supply of OPEC members, which may amount to 2.5mn b/d in the first half of 2012, oil prices remain at a high level, OPEC members can still easily continue to maintain their current production regardless of excess supply in the market. And the only thing that will happen is the exceeding of the target of 30mn b/d overall without pointing out any individual member for the violation.

Second Scenario: Direct Link Between The Fundamentals And Prices Assumption

The demand for OPEC oil in the first quarter of 2012 will be 29.84 mn b/d and in the second quarter of 2012 the call on OPEC will come to 28.98 mn b/d (Table 2).

Table 2: Supply And Demand Balance For 2012 (Mn B/D)

Source: OPEC Monthly Oil Market Report, January 2012. 

If OPEC produces 30mn b/d in first quarter 2012, the market will face a surplus of 160,000 b/d, which is unusual because normally in the first quarter there should be a stock draw-down. And if OPEC maintains its production in the second quarter, the excess supply will reach 1.02mn b/d.

However, if Iraq continues to pursue its plans to increase production, and Libya also produces according to what the Libyan minister said, the market will face a surplus of 1.7mn b/d in the first quarter and a surplus of 3mn b/d in the second quarter of 2012. 

If the OPEC estimation for supply and demand is correct and no unexpected event happens, the substantial volume of excess supply will undoubtedly affect the oil market and will push down the oil prices.

In such a situation where the oil market is under the burden of huge excess supply and downward price trends, Saudi Arabia’s decision to reduce production will be fateful. Saudi Arabia in this situation can decide to do either of the following: 

• React rapidly and decisively to the market conditions and limits its production. The decision will stop the declining trend of prices and prices will stand in the range $80-100/B.
• Not react to market conditions or wait for the pro rata reduction in OPEC, in which case the disorder between OPEC members will be intensified and the oil market will fall into turbulence. Oil prices will fall below $80/B until it becomes difficult for OPEC members to tolerate the downward trend. 

In this situation, all OPEC members have to participate in protecting the price floor and define a new production quotas and a control mechanism, as at the 151^st meeting of OPEC where the members agreed to reduce their production from the beginning of 2009 by 4.2 mn b/d, to create a balance in the market based on the actual production levels of September 2008. 

It must be pointed out that according to some studies, the Saudi budget in 2012 will be balanced by $74/B.⁶  Since it can be learned from the successful outcome of the OPEC decision at the 151^st meeting, which helped the market to achieve a new balance, there will be a strong possibility for the same reaction to occur if prices are to fall below OPEC members’ tolerance level.

Notes:

1. OPEC, ‘Monthly Oil Market Report’, January 2012.
2. Ibid.
3. Reuters, 14 December 2011: “Libya’s oil output has hit 1mn b/d, the country’s oil minister said on Wednesday after an OPEC meeting. The Libyan minister said production would reach 1.3mn b/d by the first quarter and 1.5mn b/d by the second half of 2012.”
4. Reuters, 14 December 2011: “Iraqi Oil Minister 'Abd al-Karim al-Laibi predicted that Iraq’s total oil output in 2012 would be about 3.4mn b/d.”
5. Reuters, 14 December 2011: “‘If Libya increases it doesn’t necessarily mean Saudi will cut,’ said Saudi Oil Minister AliNaimi. ‘We don’t react to that, we react to market demand,’ he said.”
6. ‘Saudis Need $74 Oil Price to Balance 2012 Budget’, Bloomberg, 27 December 2011.