Oil producers can soften the economic shock

As world markets continue to experience turbulent times, oil-producing might be better served riding out the storm than cutting production now.

Major oil producers have some difficult decisions ahead. After last week's downgrade of the United States' sovereign credit rating, and the subsequent volatility in the stock markets, there are again grumblings about a double-dip recession and stagnant global growth.

Hard on the heels of that pessimistic outlook, the International Energy Agency (IEA) predicted that demand for oil could drop by as much as 60 per cent next year. Almost immediately, there were statements about possible production cuts.

It's a moment for major oil producers to show some leadership, including Opec members from the Gulf. The last Opec meeting in June was one of the most contentious in the organisation's history. Members advocating production cuts (chiefly Iran and Venezuela) hamstrung a proposal by Saudi Arabia to raise output to boost the economic recovery. In the end, no decision was made, although both sides managed to get in some stinging remarks.

In the coming days we are sure to hear Tehran crowing about expectations of weaker demand - although it's worth pointing out that when Iran proposes production cuts, it is talking about taking Saudi Arabian oil off the market, not foregoing its own oil receipts.

But there is a point that at least deserves consideration. Saudi output is at its highest level in three decades. No one really expected oil prices to return to pre-crisis levels, hovering around $130 a barrel, so soon after the 2008 crisis.

Oil producers will obviously feel the hit if those prices drop sharply, but in the current environment that would have a silver lining. Major producers have a delicate balancing act. High prices are good for revenues, but if oil is too dear, it will stifle economic growth.

With sovereign debt crises forcing austerity on both sides of the Atlantic and diminishing growth in emerging economies, demand for oil - and in turn prices - may well drop in coming months. Producers have a choice between making defensive output cuts to prop up the price, which might further depress growth, or riding out the storm.

There is plenty of room for manoeuvre before there needs to be a full change of course.

Published: August 12, 2011 04:00 AM