OPEC’s Decision

OPEC has decided to cut back on production. OPEC’s official price target is $22-$28 per barrel, yet this decision to cut back production when the price of oil is still above $40 indicates that they actually seem to prefer prices far higher than this official price target. As The Economist puts it, OPEC seems to be demonstrating a taste for higher oil prices:

At its meeting in Cairo on Friday, OPEC agreed to pare back production to support the oil price, which has fallen towards $40 per barrel in recent weeks. Has the producers’ cartel acquired a taste for pricey oil?

…At its meeting in Cairo on Friday December 10th, members agreed to restrain their output by about 1m barrels per day (bpd), thus reinstating the official quota of 27m bpd, which they have all but ignored in recent months. The decision takes effect on January 1st but will probably not be fully implemented until February.

…The cartel is currently producing around its highest level for 25 years and stocks of oil have started to rise. As the price of crude has eased, the cartel has regained control over the market. But its control is dangerously one-sided. It can set a floor under the price, but it cannot set a ceiling. To do that, it would have to maintain a larger margin of spare capacity, probably about 4m bpd, which could be tapped whenever prices rise too far or too fast. As recently as 2002, the organisation had a cushion of 6m bpd. But now OPEC is operating with precious little to spare: only about 1m bpd in an 83m-bpd market.

This last point reveals a possible alternative explanation to OPEC’s decision to reduce production. Rather than trying to get the price of oil into its official price range target, OPEC is probably more concerned with increasing its cushion of spare capacity to give it greater flexibility to respond to future events.