"Since the market remains oversupplied and given the downside risks associated with the extremely fragile recovery, (OPEC) once again agreed to leave current production levels unchanged for the time being," the statement said.
The decision, announced in the early hours of Thursday, came as little surprise.
Saudi Oil Minister Ali Naimi, whose country is OPEC's biggest producer and its de facto leader, had sounded an upbeat tone about current crude prices and ruled out any possibility that a cut was in the offing.
OPEC ministers had indicated ahead of the meeting they were not intent on cutting quotas. Instead, the focus was on boosting compliance with production targets - seen as key to sustaining prices in a market swimming in crude and still exposed to volatility linked to weak demand, the fluctuation in the U.S. dollar and a global economic recovery that has yet to firmly take root.
The group - excluding Iraq - has set a production target of slightly under 25 million barrels per day, but has been overshooting that mark by about one million barrels per day, according to analysts.
The increase in inventories is a major challenge for OPEC, especially as the U.S. driving season winds down and refiners gear up for the winter heating oil season with refined product inventories also high.
"When we look at fundamentals, we see this overhang with great concern," OPEC Secretary General Abdulla Salem el-Badri said. "Of course, when the conference takes a decision, we would like our members to adhere to the decision," he said, noting that compliance was good, but not excellent.
But el-Badri also stressed that the group was not ready to jeopardize the economic recovery efforts by pushing for steep cuts.
"We are working on a very thin line," he said. "We have to be very careful. We don't want to take action that will jeopardize the recovery."
Commentary 1:
The article deals with the OPEC’s decision to keep production quotas unchanged as the market is oversupplied with crude oil. Abiding by the fundamentals of supply and demand, the worry of the OPEC member states involves the volatility of crude oil prices as the market is swarmed with a surplus of oil. Due to the dependence of the OPEC member states on the prices of crude and its derivatives, the organization has pledged to maintain the status quo of production quotas around the current price of $71. Essentially, as crude is the core ingredient for gasoline, its price will present numerous implications upon the market for various products.
Below is the diagram indicating the market for crude in its current state with a surplus as a result of overproduction.
As seen in Figure 1, A1 indicates the current state of OPEC oil production, which is much higher than the equilibrium point A0 indicated by Saudi representatives as around $75 per barrel, which is a “fair price for both producers and consumers”. The demand curve “D” does not meet the point A1, which reveals that there is indeed a surplus of the quantity produced of oil. A possible response to this surplus could be a price cut in the part of the producers in order to balance supply with demand, yet the article mentions OPEC has “ruled out any possibility of a cut” due to “weak demand”. Instead of modifying the production quotas, OPEC has instead opted to enforce compliance with already existing quotas, which the member states have violated by producing more than necessary.
Essentially OPEC states are attempting to maximize their potentials in attempting to maintain this status quo, believing that increasing production holds no benefits. Any implications otherwise would present serious consequences. If the OPEC were to suddenly cut back supply of crude oil, this could precipitate another oil shock similar to the cases of 1973 and 1979, in which an intentional cutback of oil resulted in a global surge in gasoline prices. Figure 2 demonstrates the immediate situation of such a cutback.
In terms of the price elasticity of supply, since oil is essentially an inelasticcommodity, the short term consequences of a reduction of supply would result in a large increase in oil price, which is indicated in the graph by the move from P1 to P2.
Nevertheless, one of the core determinants of price elasticity of supply is time. If the long term implications are weighted, in time the inelastic nature of the supply curve would turn elastic. This could be the result—in the case of oil—of increased oil exploration in non-OPEC states, as well as increased efficiency in oil uses. Assuming all agents in the market are rational maximizers, non-OPEC affiliates would try to minimize their dependence on Middle Eastern oil using every resource possible. Figure 3 highlights such a situation, where the elasticity of oil production has turned elastic over time, and there is only a small increase in price whereas demand has also largely turned elastic. In essence the total revenue of the market in the long run as opposed to the short run would decrease significantly. Such implications prevent the OPEC states from both decreasing the production and causing the above responses, or likewise overproducing like the current situation and saturating the market with more oil than necessary.
Note: Figure 2 and 3 are derived from:
Mankiw, N. Gregory. Principles of Economics. Fifth Edition. South-Western College Pub, 2008. Print.
Amount of a good or service that sellers are willing and able to sell
Amount of a good or service that consumers are willing and able to buy
Situation in which quantity supplied is greater than quantity demanded
Situation in which market price meets the point where quantity supplied equals quantity demanded
Measure of the responsiveness of the quantity supplied of a good to a change in price of that good
Percentage change in quantity supplied Percentage change in price
Percentage change in quantity supplied Percentage change in price
Price of a good multiplied by the quantity sold.