Turmoil gives Opec edge

When the world emerges from its financial turmoil, Opec could hold an even bigger share of global oil output.

Opec output will fall in the short term due to cuts to members' production quotas.

When the world emerges from its financial turmoil, recession fears and plunging commodity prices, Opec could hold an even bigger share of global oil output than its present 40 per cent. The reason is that financially secure Gulf producers such as Saudi Arabia and the UAE now have a golden opportunity to rebuild spare crude output capacity ahead of an eventual upswing in global oil demand, while non-Opec oil investment dives.

Signs of a downturn in upstream energy investment in some non-Opec oil exporting countries are already surfacing. Canada is a good indicator, as its oil production costs are among the highest in the world, while profit margins from pumping mainly heavy grades of crude are among the world's lowest. At present prices, near US$70 a barrel, many Canadian oil projects were "marginal, if economic at all, for investment", the vice-chairman of one of Canada's biggest oil producers, Canadian Natural Resources, said last week.

Analysts estimate that for acceptable returns on investment, Canadian oil sands, offshore oil and Arctic oil projects require prices above $90 a barrel. Little wonder, then, that the country's biggest oil and gas producer, EnCana, said last week it would focus on "capital preservation" to tide it through uncertain times, as it cancelled plans to spin off its oil sands business. That means drilling cutbacks, slower development of oil sands ventures, and no borrowing to bolster coffers that will be limited to the shrinking profits from oil and gas production at lower energy prices.

Elsewhere in the world, Sherritt International, a Canadian metals and oil enterprise, recently shelved plans to drill for oil in Cuban waters. In Europe, the credit crunch is forcing smaller operators to sell assets and renegotiate debt as they struggle to keep on drilling. Oilexco, a British company operating in the North Sea, lowered its 2008 production target and said it was having difficulty raising its credit lines to $1 billion (Dh3.67bn) from $700 million.

"Tightening credit and equity markets will slow the pace of investment, with smaller, independent producers and, potentially, several Russian operators seen as particularly at risk," the Paris-based International Energy Agency (IEA) said in its October oil market report. "Some analysts envisage a sizeable proportion of current global drilling rig orders will be cancelled." The agency said credit shortages would intensify the effect of other factors limiting oil industry investment, including restricted access to oil reserves and tightening fiscal barriers. "In short, expanding production capacity, even in line with moderate demand growth, becomes more difficult," it said.

The IEA, together with Opec in its latest market report, still expect non-Opec oil supply to grow next year, but has cut its forecast from a month ago. It predicts declining output from Mexico, western Europe and Russia. "Investment is already being affected at a number of highly leveraged companies in locations such as Russia and the Caspian," it said. "Ambitious expansions plans for national oil champions like Brazil's Petrobras, which will need upwards of $500bn to finance its offshore sub-salt development programme, may be further delayed as share prices tumble and amid restrictions on the availability of state development bank funding," the agency added.

Schlumberger, the world's biggest oilfield services provider, said yesterday its growth may slow after it announced sharply higher third quarter net income. Its chief executive, Andrew Gould, said deteriorating credit markets "undoubtedly" would affect the firm's activity. Opec output, meanwhile, will fall in the short-term, but due to cuts to members' production quotas, and not necessarily to slowing oil investment. "It is obvious that to ensure market balance, supplies must be reduced," the group's president, Chakib Khelil, said yesterday, less than a week before Friday's emergency Opec meeting.

To be sure, some Opec countries will struggle to maintain production capacity. The price of Venezuela's heavy crude has fallen to $68 a barrel - a level that could force its president, Hugo Chavez, to cut government spending. According to industry sources, the condition of the country's oilfield infrastructure has been deteriorating as Mr Chavez has diverted funds to projects more likely to boost his domestic popularity.

Iran, facing a presidential election next year, may further slow plans for oilfield development that are already being hampered by US-led economic sanctions. Iraq's plans for rebuilding its decrepit oil industry continue to face huge uncertainties, but mainly for political reasons. The Kuwaiti finance minister Mustapha al Shamali warned in remarks published yesterday that Kuwait would have to cut public spending if the price of its crude fell below $60 a barrel. But with its treasury well stocked, the country is unlikely to neglect the cash-cow providing most of its revenue by cutting oil development spending.

As for Saudi Arabia, the Opec kingpin has shown less enthusiasm for production cuts than the group's other members. It, too, is likely to protect its major revenue source by continuing to pump money into refurbishing ageing oilfields and developing new ones. And if Opec's publicly stated aim of stabilising oil prices is to be taken seriously, the kingdom will need to do this in order to preserve its role as swing producer.

According to analysts, shrinking Opec spare capacity has been a major contributor to oil price volatility. [e-mail]