OPEC Risks Split Over Oil Cuts as Economies Reel, Prices Drop

By Grant Smith and Margot Habiby

Oct. 22 (Bloomberg) -- OPEC, founded five decades ago to unify oil producers, risks dividing members as the group plans to cut output and raise prices just as developed nations face their worst recession since 1983.

Iran's energy minister, Gholamhossein Nozari, said yesterday OPEC may slash output quotas by 2.5 million barrels a day, or 8.7 percent, an amount about equal to what's pumped from Kuwait. The Algerian minister and OPEC president, Chakib Khelil, said two days earlier the reduction may be only 1 million barrels.

The debate in the Organization of Petroleum Exporting Countries pits Saudi Arabia, the group's biggest producer and a U.S. ally, against Venezuela and Iran, two nations that oppose U.S. foreign policy and advocate higher oil costs. Crude plunged 52 percent to $70.89 yesterday from its July 11 record of $147.27 on the New York Mercantile Exchange.

``The divisions arise in OPEC because what countries need and want varies,'' said Gareth Lewis-Davies, an oil analyst at Dresdner Kleinwort Group Ltd. in London. ``The Saudis are playing a long-term political game. Other countries have higher costs.''

Saudi Arabia needs oil prices of less than $30 a barrel to balance its government budget, according to Merrill Lynch & Co. estimates. The United Arab Emirates requires $40 a barrel and Qatar $55.

Iran, with double the population of Saudi Arabia, has a breakeven point of about $100 a barrel, according to Edward Morse, managing director and chief economist at Louis Capital Markets LP in New York. In Venezuela, where President Hugo Chavez's government is spending oil revenue on social programs, the figure is about $120, he said.

Below $50

Oil options trading shows the probability that crude will fall below $50 a barrel by June has more than doubled in 10 days, Deutsche Bank AG said in an Oct. 17 report. There is a 9 percent likelihood that June 2009 crude oil contracts will expire below $50, up from 4 percent, Deutsche said.

The world's industrialized economies will expand next year at the slowest pace since 1982, the International Monetary Fund said Oct. 8. Growth will weaken to 0.5 percent in 2009, from 1.5 percent this year, sending U.S. unemployment to its highest level in 16 years, the agency said.

Oil demand may fall for the first time in 15 years this year as the worst financial crisis in decades tips economies into recession, according to the Centre for Global Energy Studies, a London-based consulting company.

Different Agendas

``OPEC members have completely different agendas,'' Merrill Lynch analysts led by Francisco Blanch said in an Oct. 20 report. ``History shows that it is difficult to maintain discipline in a falling price environment, and OPEC cohesion has already started to decline.''

Eleven years ago, OPEC members bickered about output quotas as oil slid 28 percent in 10 months amid the onset of the Asian financial crisis. At a meeting in Jakarta in November 1997, they raised quotas, ignoring the turmoil that slowed Asian economies and cut oil demand. Prices fell another 44 percent by December 1998 to below $11 a barrel.

``OPEC members are worried that they will be slow to react and oil prices will drop to $50 or $40 a barrel,'' said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts.

After the late 1990s price drop, Saudi Arabia, Venezuela and non-OPEC nation Mexico led efforts to cut production to boost prices.

``The death of OPEC typically comes up as a question or a theme at times when prices are falling dramatically,'' said Tim Evans, an energy analyst at Citi Futures Perspective in New York. ``It is exactly at those moments when the OPEC membership tends to recognize that they need to come up with a combined response to the market.''

`Consensus to Reduce'

Algeria's Khelil said ``there is a consensus to reduce production, but there is no agreement on how much to cut'' on Algerian television Oct. 19.

Saudi Arabia, where officials haven't made any comments before this week's meeting, is likely to resist a cut of more than 1 million barrels because it's conscious of the political response in the U.S. and other consuming countries, said John Sfakianakis, chief economist at Saudi British Bank in Riyadh.

``I don't think we will see a 2 million-barrel cut, given the reaction that this will have both by the market and by the politicians,'' Sfakianakis said in a phone interview.

Saudi King Abdullah said at a June 22 oil summit in Jeddah that the world's largest oil-exporting nation seeks ``reasonable'' prices to producers and consumers.

`Absolutely Scandalous'

U.K. Prime Minister Gordon Brown said last week that it was ``absolutely scandalous'' that OPEC is considering cuts as the global economy risks falling into a recession.

At OPEC's last meeting in September, the group's members agreed to adhere more strictly to production quotas, trimming output by about 500,000 barrels a day.

Saudi Arabia produced 9.45 million barrels a day in September, according to Bloomberg estimates. Its output target is set at 8.94 million barrels. Iran, OPEC's second-largest producer, trimmed production by 130,000 barrels to 3.95 million barrels day, close to its quota of 3.82 million barrels, according to Bloomberg estimates.

Saudi Arabia will probably forge a compromise for production cuts to be taken over coming months instead of all at one time, analysts said.

``Everyone recognizes that oil needs to be taken off the market,'' Morse said in a phone interview. ``If they cut a million, they will almost certainly have to go in for a second round of cuts.''

OPEC members will meet again in Algeria in December.

To contact the reporter on this story: Grant Smith in London at gsmith52@bloomberg.net; Margot Habiby in Dallas at mhabiby@bloomberg.net.