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No sign of major OPEC cut as ministers haggle before meeting

Saudi oil minister Ali Al-Naimi prepares to put the squeeze on rival producers both inside and outside of OPECPhotograph by Yasser al- Zayyat —AFP/Getty Images

Ministers from the Organization of Petroleum Exporting Countries are gathering in Vienna for what is being billed as their most important meeting in decades.

The cartel that produces a third of the world’s oil has to decide whether to let prices continue to fall, under pressure from surging output in North America, or to cut output to bring it back into line with global demand. If they choose the latter, then they will also have to thrash out the highly tricky question of who will bear the brunt of the output cuts.

The meeting will have ramifications far beyond the 12 countries that make up the cartel.

Crude prices have fallen 28% since the summer to their lowest level in over four years, shaking oil companies and producer countries out of the cozy thought that prices would stay at or above $100 a barrel forever, according to analysts at Barclays.

If OPEC can agree on how to share the pain, it can squeeze price back up to $100 a barrel, but if not, then producers and companies will have to get used to a new reality, and cut their cloth accordingly. For Russia, that could mean abandoning grandiose new plans for rebuilding its armed forces. For Big Oil, it could mean lower dividends and investment.

The current oversupply has pushed gasoline prices in the U.S. below $3 a gallon. In the U.S., and across much of the world, that slump is acting as a de facto tax cut, creating additional disposable income out of nothing, says Graham Martin, managing director of Optima Fund Management, which has $4.4 billion in assets under management.

From China to Europe, that’s an important prop to economies that are all either slowing down or flirting with recession.

By the same token, countries such as Mexico, Brazil and Russia, which are big producers of oil, but which aren’t members of the cartel, will be hoping that OPEC will take the strain rather than allow a free-for-all that would eat into their budgets and current accounts.

It’s precisely that kind of free-riding that OPEC’s de facto leader, Saudi Arabia, has taken offense at in recent months, slashing its prices for Asian customers in an effort to defend its market share.

Oil Minister Ali Naimi struck a nonchalant tone on arrival in Vienna, saying only that “it’s not the first time the market is oversupplied,” according to Reuters.

Naimi met later with officials from Venezuela, Russia and Mexico, but there was no sign of any agreement of a coordinated cut in production. As a result, crude futures fell to within a whisker of a new four-year low at $74.31/bbl.

Low prices are less of a problem for Saudi Arabia and other low-cost producers such as Kuwait and the United Arab Emirates than they are for Iran, Venezuela and Nigeria (and Russia and Brazil), all of whom have to spread their export revenues across larger populations.

Reuters quoted diplomatic sources as saying that the kingdom, with its large currency reserves, was prepared to withstand oil prices as low as $70-$80 a barrel for up to a year. By contrast, says Craig Botham, chief emerging economist at Schroders in London with $464 billion under management, Russia needs an average oil price of $114/bbl this year to balance its budget, and can’t access western debt markets to fill any deficit that arises.

Over and above the budget arithmetic, Botham noted that Russia needs a high price to maximize its geopolitical leverage, a key concern as it tries to stake its claim to influence in neighboring Ukraine, while Mexico could use a high price to improve the bid levels when it auctions new exploration blocks in the near future.

For Big Oil, the situation is less acute. Barclays analysts reckon that most majors can live with $70/bbl for two years and $80/bbl for three, without compromising their dividends and still have enough money to invest in new production. The big unknown is how quickly U.S. shale oil production (believed by many to be the ultimate target of Saudi Arabia’s price war) will slow down at those price levels.

Barclays reckons OPEC needs to cut output by 1.5 million barrels a day from its current level of just under 31 million b/d to balance the market. But news agency reports from the preliminary meetings in Vienna suggested that nothing on that scale was going to be agreed.

Instead, the cartel may agree just do what it has done many times in the past–promise to do a better job in respecting the current output quota (they currently pump almost 1 million barrels a day more than agreed, according to Bloomberg) and call that a cut.

The market has generally seen through that kind of wordplay in the past and it seems likely to do so again.