The OPEC quota increase: Fact and fiction

Published October 10th, 2000 - 02:00 GMT

The abrupt increase in the price of oil that started in February 1999 motivated the usual frantic "market diplomacy" on the part of the U.S. government along with the traditional congressional hearings. 

 

The United States pressured OPEC member countries to increase their production quotas. Congress suggested selling part of the strategic oil reserves. Sanctions to punish OPEC members for their cartel-like behavior were also considered. 

 

George Bush Jr. recently suggested a more constructive alternative: Lower the taxes on hydrocarbons in order to alleviate the load on his fellow citizens ... and voters in the upcoming December elections.  

 

The Venezuelan Energy and Mines Minister, Alí Rodríguez, has questioned the disproportionate weight of taxes on the final price to the consumer and suggested that the OECD member countries reconsider their fiscal policies.  

 

To back this point, we can make some simple math calculations and extrapolations in order to arrive at quantitative deductions on the macroeconomic impact of oil prices, and who is to blame.  

 

Let's refer, for example, to the latest U.S. consumer statistics. The U.S. consumes 19.5 million barrels per day (MMBD) of hydrocarbons distributed (approximately) in 8 MMBD of gasoline, 4MMBD distillates, 1.5 MMBD jet fuel, 1 MMBD residuals and 5 MMBD other products. 

 

So as to facilitate our mathematical effort, we can "round out" the amount consumed to 20 MMBD and multiply this figure by 10 (i.e., an increase of $10 per barrel). This translates into an increment of $200 million a day for the U.S. market; in other words, $73 billion a year. Of this figure, only half can be attributed to OPEC since our northern neighbor imports only 50 percent of its oil.  

 

The rest of this amount goes directly into the pockets of North American citizens or corporations involved in this activity (without mentioning the income taxes they also contribute to the U.S. government). 

 

The component that can be directly attributed to OPEC does not exceed $36 billion a year. The Gross National Product (GNP) of the United States of America exceeds $9,300 billion.  

 

We can, therefore, conclude that price increase, that can be attributed to OPEC, has an impact of less than 0.3 percent of this total. When the Dow Jones drops by 1 percent, $100 billion of wealth "evaporates"? So what's the big deal?  

 

The True impact and the real story 

Last year, gasoline prices increased 50 cents to one dollar per gallon depending on where the consumer filled his tank. Prices, of course, have receded since the 1.7 MMBD production increase agreed to by OPEC members. 

 

For the purpose of this exercise, let us use a one-dollar increase as an estimate for our calculations. Consider gasoline, distillates and jet fuel. Consumption for these products totals 13.5 MMBD. Each barrel contains 42 gallons, which translates into a consumption of 567 million gallons ea6 day. (MMGD). 

 

A one-dollar increase impacts costs to the tune of $567 million a day or $200 billion each year, without counting other products consumed such as residuals, etc.  

 

These costs also have an impact on the final price for each unit of BTU or KWH to the consumer (be it for heating or electricity).The effect on the North American economy now becomes 3 percent of GNP. However, 70 percent of this cost corresponds to the chain of commercialization and fiscal taxes.  

 

The proportion is even greater for the European countries. In Germany, for example, crude composes only 15 percent of the final price to the consumer. 

Considering Europe's GNP exceed $9,400 billion and its population i slightly under 450 million inhabitant (50 percent larger than the U.S. population), the impact in Europe should be greater ... except that these countries use their taxes as a shock absorber.  

 

Updated stats  

Trends do not favor OECD countries. For example, the number of registered cars in the U.S. increased from 120 million in 1980 to 142 million in 1992 and almost 170 million today. 

 

The consumption per automobile fell from 771 gallons in 1973 to 496 gallons per car in 1991.However, this trend seems to be reversing itself. Although fuel efficiency increased from 13.3 miles per gallon (MPG) in 1978 to 21.7 MPG in 1991 ... technology seems "stuck" at this level.  

 

The distance covered per vehicle in the U.S. increased from 10,500 miles annually to 11,725. Air transport has also increased significantly. It is understandable that the U.S. government, after being informed that refinery inventories had dropped to 15 days equivalent of consumption, should overreact. Who wants long lines of cars with angry voters waiting to fill up their tanks ... especially in an election year? 

 

Is the increase in production a justifiable answer to lower prices?  

After considering the above arguments and statistics, the reader might conclude that the production increase agreed to by OPEC countries in March was a mistake. 

 

 

Could Iran have been right in its initial rejection of the proposal? After all, the U.S. has the lowest hydrocarbon prices of all industrialized nations: $0.360 per liter in the U.S. versus $1.228 for Great Britain, $0.973 in Germany and $1.066 in Japan. 

 

Even Mexico has a higher cost at $0.397 per liter. Why, then increase production? Obviously we should not do so for altruistic reasons. The intent is not to introduce a new form of "market philanthropy." After all, the price levels reached during the month of March will not cause a global recession. Our reasoning is quite different.  

 

We should fear an increase in supply more than a decrease in demand. History has shown us that prices act as market catalysts when they surge above $20 per barrel (WTI). According to the Baker index, drilling activity increased 40 percent in the last year. Oil industry exploration and production budgets increased 20 percent in 1999.  

 

These developments usually precede a large-scale supply increment. The effect is greater as the prices increase. A price band of $20 to $25 will best "balance" the market. 

 

We will preempt the volatility of drastic price changes and maximize, at the same time, our income over time. We can justify the production quota increase as a means to protect our market share ... and for no other reason.  

 

The new paradigm of OPEC can be summarized as follows: The probability it can raise prices versus the certainty it can reduce them. The best way to control competitive forays into our markets will be OPECs ability to decrease prices at any given moment so as to recapture market share.  

 

We can thus participate in the same market game that others have dominated up to this moment.In conclusion, the production increase was a good move. 

However, we believe we should have increased only 1 million barrels per day at this time so as to "test" the market.  

 

This would have left us with the option for further increases, if necessary, at a later date ... as opposed to having to scramble for new cutbacks.This article was first on line on Venezuela Oil & Energy web site.  

 

Alan J. Viergutz is a well known Venezuelan oil expert, is CEO of the Venezuela Centec Group and is a former president of the Venezuelan Petroleum Chamber and a Former Venezuela's representative in OPEC. His views are not necessarily those of Petroleumworld.Com 

(PETROLEUMWORLD )  

By Alan Viergutz CEO Centec Group  

 

 

 

© 2000 Mena Report (www.menareport.com)

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