Jewish World Review April 29, 2003 / 27 Nissan, 5763

David DeRosa

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U.S. Victory in Iraq Could Be OPEC's Problem


http://www.jewishworldreview.com | (Bloomberg) New Canaan, Connecticut, April 25 (Bloomberg) -- Remember all those doomsday forecasts of expensive crude oil if a U.S.-led coalition ventured into a war against Iraq?

Just the opposite outcome has materialized. The coalition's speedy victory over Saddam Hussein's regime has triggered a plunge in crude oil prices. And that has the Organization of Petroleum Exporting Countries in a tizzy.

Crude prices began moving up in mid-November from about $23 a barrel for Brent crude in London. The price rose to almost $34 on March 13, about a week before the fighting began.

Two weeks later it was $24. That's why OPEC met yesterday to agree on reducing daily production by 2 million barrels. For some reason, the OPEC oil ministers have decided the correct price for oil is $25 a barrel. This is their line in the sand, so to speak, that they appear ready to defend by adjusting production.

The price target is measured by an arithmetic average of oil produced by six OPEC members and Mexico. This price was last officially calculated to be $23.97 on April 24.

Up or Down

OPEC President Abdullah bin Hamad al-Attiyiah, who is also Qatar's oil minister, cautioned that ``we may need another cut in June.'' That second cut could come as early as June 11 when the ministers meet again in Doha, Qatar.

If so, then one other thing the ministers did yesterday makes no sense. While they did cut daily oil production by 2 million barrels, they also raised the official ceiling target to 25.4 million barrels a day, an increase of 900,000 barrels.

That change will go into effect on June 1. So what gives? Sounds like the ministers regard the current oil glut as temporary. When it ends they can go to the new, higher production?

Or perhaps these fine gentlemen think they can independently control both the price of oil and the amount they produce.

OPEC accounts for about a third of all crude production. While not exactly a monopoly in the classical sense, OPEC is a major factor in the market.

The price of oil went up because Iraq was on the verge of war. The war ended; the price fell like a rock. In both cases OPEC was incidental to the price action on crude. World events -- including speculation that Iraq's oil wells and reservoirs would be severely damaged in a war -- not OPEC, caused the price blip to happen and then to go away.

Iraq the Key

It would be fascinating to learn what the OPEC ministers were saying at their meeting about the U.S.-led coalition's victory over Hussein. It would be more important to know what they thought about Iraq's future as a member of OPEC.

Since the coalition plans to use Iraqi crude sales to finance part of the country's reconstruction, it means a lot of Iraqi crude will be coming to market in the next few years. And that could become a very contentious issue within OPEC. On one hand, Iraq needs to sell a lot of oil. On the other, OPEC needs Iraq not to sell a lot of oil.

The question then turns on the extent of the coalition's control of Iraq's immediate future. Said another way, should the coalition be bound by OPEC's production guidelines because Iraq is a member of the group? Iraq hasn't had an oil production quota since the end of the first Gulf war.

If the U.S. and the U.K., the dominant coalition partners, end up supporting OPEC's attempts to control the price of crude, it would be a truly ridiculous outcome of the war.

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David DeRosa , president of DeRosa Research & Trading, is an adjunct finance professor at the Yale School of Management and the author of "In Defense of Free Capital Markets." Comment by clicking here.

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