Washington Report on Middle East Affairs, April 2000, page 68

Trade and Finance

OPEC’s Embarrassment of Riches—Now What?

By Colin MacKinnon

What a difference a year—and production cutbacks—can make. Just over a year ago, in January 1999, OPEC’s market basket price for crude averaged $10.74 a barrel. This was the lowest it had been in constant dollars for almost a decade and represented a dispiriting, even frightening specter for governments having to produce national budgets. (The low point was actually in December 1998 when Arab Light, a component of the market basket, fell to $7.43 a barrel on the spot market, an astounding event.)

But, still in 1999, prices began a steady climb, averaging $17.47 over 1999 as a whole, to reach $23.42 a barrel in January 2000. By mid-February, the spot market price in New York for light petroleum to be delivered in March rose to $29.44. There has been, in short, a stunning reversal of fortunes, one that will affect all Middle East economies for the better this year.

The change is due to three factors: economic recovery in Asia, the coming of winter to the Northern Hemisphere, and, more than anything, OPEC’s production cuts of 1999 and its ability to maintain them throughout the year with less than the usual fiddling on quotas.

It was in March last year, after a 30 percent decline in income in 1998, that OPEC members meeting in Vienna agreed to production cuts of 1.7 million barrels a day in addition to cuts that had been agreed (but never observed) in 1998. Altogether, the cuts of 1999 amounted to 4.3 million barrels a day, a large chunk of the market. At the same meeting four non-OPEC members, Mexico, Norway, Russia and Oman, promised to cut their production by a total of 400,000 barrels a day.

OPEC Maintained Discipline

Promises do not always result in deeds, naturally, but in this case they did, more or less. From March 1999 until last fall, say analysts at the U.S. Department of Energy, OPEC producers made about 80 percent of the cuts they had said they would. This figure dropped a bit in the final quarter of 1999, to 74 percent.

Nonetheless, though not 100 percent in effect, OPEC cuts have had a dramatic effect on oil stockpiles and prices.

Improved Performance in 2000

As a result, higher revenues have been pouring into producer nations’ coffers for a year now, and there has been a major shift in the economic prospects of the region.

According to the Economic and Social Commission for Western Asia (ESCWA), a U.N. development agency headquartered in Beirut, the economies of the Arab Middle East (excluding Iraq) will see an average growth in Gross Domestic Product of a bit over 4 percent this year. Gulf Cooperation Council states should see their economies grow 3.8 percent this year.

States with more diversified economies should do even better, averaging 4.7 percent growth. Egypt will lead the field of such states with growth of 6 percent. And thanks to the higher revenues, most governments will show budget deficits of 3 percent or less this year. (An exception is Lebanon, which ESCWA expects to have a 12 percent deficit in 2000.)

Four percent economic growth is by no means spectacular, but it’s better than the performance of the previous two years. According to ESCWA, regional economies grew 2.8 percent in 1999, an anemic performance which was nonetheless better than the year before, when regional GDP rose only 1.89 percent.

1999’s improved performance was mostly due to higher oil revenues over the year, even though some Arab Middle East states—Lebanon, Jordan—produce or export no oil. The reason is that when oil exporters are relatively flush, they buy more, employ migrant workers, go on more touristic jaunts, and are more generous with public and private aid.

Inflation in the region was low last year, ranging from 0.5 percent in Bahrain to 4 percent in the Palestinian Territory. Saudi Arabia, the most important economy in the region, had an estimated inflation rate of a mere 1 percent.

ESCWA believes oil prices will continue to be on the high side and that production will be up as well in 2000.

Even so, most states of the region, including top oil producers like Saudi Arabia, can’t really claim to feel flush. The Kingdom announced a cautious budget in December, with only a 2 percent increase in spending and highly conservative assumptions about oil revenues.

The U.S. Energy Information Administration, part of the Department of Energy, is predicting that Saudi GDP growth will be 5.1 percent this year, a respectable performance but, again, not spectacular (the Saudi government is predicting 8.4 percent).

Note, also, that over the past decade or so Saudi economic growth has not kept up with population growth. What that means is that everybody’s income in the Kingdom actually declined over that period. Much the same can be said for other regional oil producers.

Therefore, when OPEC oil ministers meet in Vienna toward the end of March, they will confront a problem they haven’t seen for quite a while: an embarrassment of riches.

What Will They Do?

There is of course no telling—we’ll know after the meeting. But the oil ministers of Algeria, Iran, and Libya—three hard-line and cash-strapped oil states—met this January and recommended extending production cuts through September. Three days later Kuwait’s oil minister, Saud Nasser al-Sabah, said that the extension of cuts into next fall was an option, but didn’t say whether Kuwait ultimately would back them.

Always hanging over OPEC deliberations, however, is the threat that if prices go too high, consumers will find other ways to produce energy—uneconomical oil fields will suddenly become economical, and other forms of energy will become more attractive.

The ministers may well conclude that markets have swung too far against consumers to be in the producers’ best interests and that extra crude supplies will be needed to bring prices down.

There is much to suggest the ministers are leaning toward this conclusion. U.S. Energy Secretary Bill Richardson, who made a swing through producing countries in late February, seems to have persuaded Kuwait, which had been ambivalent on the issue, to favor increased production. Other key producers such as Saudi Arabia appear to favor a price in the low $20s. If the oil ministers vote to increase production, higher pumping may occur as soon as April.

Colin MacKinnon is contributing editor to the Washington-based Middle East Executive Reports.