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A further drop in oil prices means tentative times for the OPEC

Precise takes a look at how the OPEC plan to deal with this latest drop in oil prices.

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Winter is coming but will it boost sales of oil to warm homes and the hearts of producers or see a freeze in relations between oil producing nations and sink prices? That’s the big issue facing the industry as we near the end of 2014 and the final OPEC meeting of the year.

To date we’ve seen the biggest drop in oil prices since 2010 – down 30% from its price of $115 in June. Global demand is down as the Chinese economy slows with warnings about red lights affecting the Eurozone as well; there’s division within the Middle Eastern players about how to tackle ample supply; US drillers face an uncertain future as shale production reaches the point of unprofitability and, while falling prices puts smiles on people’s faces as they stop to fill up on the M4, any drastic cut in domestic oil production will leave the Chancellor scrabbling to find a way to plug the hole left by dwindling tax receipts.

The International Energy Agency says, “The oil market has entered a new era with lower Chinese economic growth and booming US shale output, making a return soon to high prices unlikely..” – words which will hardly put a spring in the steps of anyone in the industry.

As a result, to say OPEC faces a challenge is an understatement. The November 27 meeting is set to be one of the most difficult in years.

Does it do nothing, keep output as it is and allow low prices to correct the market by forcing production cuts in other nations unable to cope with decreasing revenues? That’s what the Secretary General Abdulla al-Badri said last month he’d like to see. He urged markets not to panic, saying that output of higher-cost oil supplies such as shale would be curbed if oil remained at around $85 a barrel, while OPEC enjoys lower costs and higher demand for its crude in the longer term.

Or does it stem the flow now and hope the likes of US drillers respect the move and act similarly with their own shale production? With no guarantee that a cut in output would resurrect the market permanently, not acting in the wider group’s interests now could see the US left out in the cold in the future.

A further complication is this – if OPEC chooses the latter, will it be an equitable split among all members or will the countries most able to shoulder the burden – Saudi Arabia, Kuwait and Abu Dhabi – be expected to stand up?

The OPEC relationships are complicated. Saudi Arabia will most likely want all members to take the same hit. But Iran won’t see it that way. It accuses Saudi of benefitting from US sanctions and increasing its market share. However, recent easing of these restrictions under Obama have seen Iran enjoy a tentative economic recovery and led Gulf Arab states to suspect further good relations between the two countries – possibly heralding a historic settlement over Iran’s nuclear programme – which could see foreign investment and technology entering the country’s oil industry. That could double Iran’s output and potentially lead to a challenge in OPEC’s leadership in the future.

Veteran oil producers were confident earlier this month that OPEC would make some move towards supporting the market. Vitol’s chief executive Ian Taylor says, “ My feeling is we’re underestimating now the possibility of OPEC cutting. I think there will be serious discussions at the meeting about cutting.”

But that impression isn’t universal. Trafigura’s Chief Financial Officer Pierre Lorinet says he can see OPEC and Saudi Arabia playing the long game. “A low price for a period of time may actually play into the hands of people with a lot of reserves in the ground at cheap cost.”

Within the space of a week Kuwait went from being confident in a rebounding of prices to holding an ‘extraordinary’ joint meeting to consider measures to stop the continual slide in prices. Iran’s oil minister Bijan Namdar Zangeneh also met with officials from UAE on Tuesday to further discuss the situation.

With just over a week to go before the hotly anticipated meeting Badri says “The most important thing is that we should not panic. Unfortunately, everyone is.” But warnings from Russia about what would happen if oil prices hit $60 a barrel in 2015, as well as the expectation of a resolution of talks over Iran’s nuclear programme three days before OPEC meets (Nov. 24) – with subsequent lifting of sanctions and all that that would mean for the oil market – will do little to calm nerves.