OPEC Wants Higher Floor--To Match Ceiling

OPEC Wants Higher Floor--To Match Ceiling (from Dan Ackman - Forbes.com)
The world price for oil has been going down for the past week, though it has been going up for the past year. Now, in response to the recent price drop, OPEC is talking about cutting production, where very recently Saudi Arabia was pledging to increase it. OPEC, it seems, wants a higher floor, which is only natural considering how high the ceiling has been raised.

Today, the price of crude oil climbed in back over $43 per barrel in European trading, with the reason for the day being fears that the international cartel may cut production to staunch the recent price drop down from over $50. There was also new oil-related violence, this time reports of attacks on the U.S. consulate in the Saudi city of Jeddah, production problems (a field in the North Sea) and labor issues (Nigeria). The fundamental trend--increasing demand and strained world supplies--remains in place.

Back in May, when oil was at $39 per barrel, OPEC announced it was raising its target price to $28. This was odd as the reality was still far ahead of the goal. At that time, part of the reason OPEC nations wanted higher prices--apart from the obvious--was that the dollar had been falling relative to other world currencies. This meant that an OPEC minister or Saudi prince shopping for couture in Paris or condos in Switzerland would have fewer euros than he expected, despite the rising dollar price for oil. If, however, they would buy that same condo in Manhattan, they would have no problem. Plus Donald Trump could always use more business.

Now, six months later, the dollar has fallen further, even if the oil prices have risen. Thus, our Saudi prince faces the same difficulty. So now they want the floor higher as they plan for a meeting of the ministers in Cairo on Friday.

Americans, by the way, have something like the opposite problem. While oil is still priced in dollars, higher oil prices raise the total outlay for oil, most of which is imported (not necessarily from OPEC or the Middle East, but from somewhere). For every $1 rise in the price of oil, America sends another $4.4 billion overseas, adding to the already mushrooming budget deficit, created mostly by the demand for cheap manufactured goods.

If world oil markets start pricing oil in euros rather than dollars, the problem for the U.S. would be worse. The value of the dollar relative to the euro has fallen by one-third in one year. Meanwhile, the price of a barrel of oil has risen by about 50%. If Americans were buying their oil in euros rather than dollars, the price for oil would be up by 75%. (See: "America's Quarter-Trillion-Dollar Oil Bill.")

This situation has not escaped OPEC's ministers. Two years ago, Javad Yarjani, head of OPEC's petroleum market analysis department, gave a speech to the European Union on whether oil contracts might be priced in euros rather than dollars. Yarjani had a lot of nice things to say about the euro. It had "potential to be a viable competitor," he said. But he noted also, "From the time the euro was floated in January 1999, the currency drifted downwards, losing by October 2000 about 30% of its initial value against the dollar."

Now, of course, the euro has regained its loss and moved ahead. But the world's oil sellers never made the change that, in retrospect, would have made them substantially richer.

"Naturally, the trading of oil in dollars has served the interests of the U.S., giving it an immediate advantage over other countries because it carries no currency exchange risk," Yarjani said back in 2002. But as OPEC was "mainly interested in a currency that provides a stable store of value for their revenues," dealing in dollars was just fine.

Now, that stable store theory appears kaput. Oil stocks like ExxonMobil, BP and ChevronTexaco continue to trade higher. Oil and gas drillers like like Trans-Ocean and GlobalSantaFe are up as well, though all have fallen back with the recent cut in crude prices.

The wider trend toward higher prices, and with OPEC now saying it will do what is naturally in its interest, and with even the possibility that the oil currency may change to euros, with the floor coming up to match the ceiling, the U.S. energy outlook has turned gloomier.