Carola Hoyos Opec’s oil production rises: is the cartel’s discipline crumbling?

At Opec’s latest meeting in March, oil ministers could not have been any clearer as they pledged to comply fully with their promised production cuts of 4.2m barrels per day, agreed last year.

But in the past two days Opec, and the IEA, the ‘Opec’ of oil-consuming countries, both came to the conclusion that the producers’ cartel had not kept its promise.

Instead, Opec compliance slipped by about 230,000 barrels a day, or two percentage points, to 78 per cent.

That’s still an impressive number…until you look at how that compliance is spread among members.

Ironically, Opec’s current president, Angola, and its most fervent supporter of ever deeper cuts, Iran, are its biggest cheats. Angola even wants to make its free-riding official, having written a letter to the secretariat to exempt it from current quotas on hardship grounds because of its 30-year civil war (which ended a while ago) and the economic recession (which affects everyone).

Meanwhile, Saudi Arabia, Opec’s biggest member by far, is still holding back more oil than its quota dictates (though it did pump more than everyone else when prices hovered around $147 a barrel last summer). But even the kingdom decided it didn’t have to do any more in the past two months.

The reason? Success.

Oil prices have risen from the $32-low in February – a very scary number for any oil producer – to $60 today. That makes cheating more attractive as an extra barrel pumped today brings in almost double what it did three months ago.

Simple game theory suggests such free-riding will eventually completely unravel Opec’s resolve as more and more members jump from being good soldiers to trouble-makers. The result: Oil supply increases and prices fall.

Game theory also says communication could improve Opec’s chances of success.

The cartel’s next opportunity for communication comes on May 28.

If the group wants to maintain its discipline, the topic of communication needs to focus on the dismal outlook for demand. The IEA today suggested demand in 2009 would contract more than it has in any given year since 1981, and Opec yesterday warned that the oil price rise had little to do with oil market fundamentals.

One look at inventories suggests they are right. If Opec wants to draw down those stocks it needs to maintain its current compliance level. But even that will only make things better for the cartel very slowly, the IEA says.

It appears Opec’s work is far from over, however sick and tired many of its members may be with foregoing revenue by cutting their output.