OPEC Collision Has One Likely Outcome

06/12/2012 5:19 pm EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

Upcoming OPEC elections and expected jockeying for position by member nations is likely to create some price stability in the near term and potential for rising oil prices in the fourth quarter, explains Jim Jubak.

Saudi Arabia and Iran are headed for a high-speed collision at the Thursday, June 14 Organization of Petroleum Exporting Countries (OPEC) meeting in Vienna.

That much is clear.

What’s not at all certain is what effect the collision will have on oil prices. (OPEC pumps about 40% of the world’s oil.) Plus, this OPEC meeting is more fraught than most because there are two big items on the agenda.

First, OPEC is set to elect (or at least discuss electing) a new secretary-general and both Saudi Arabia and Iran are pushing their own candidates. With the two countries locked in radically different positions on expanding/contracting OPEC production, I think the door is wide open to the selection of one of the compromise candidates backed by Ecuador or Iraq. (Of course, OPEC could deadlock. From 2004-2007 the organization was without a secretary-general because members could not agree on a candidate.)

Second, the Saudis have proposed that OPEC raise its official production quotas in order to keep global oil prices at $100 a barrel or less (for benchmark Brent crude.) The Iranians, who have seen their oil exports drop due to sanctions imposed by the United States and the European Union, want OPEC to lower production so that prices climb and oil importers have fewer alternatives to buying Iranian oil.

Saudi Arabia has raised its production above its quota to increase supply and lower prices during the current global economic slowdown. The Saudis say that it is in OPEC’s self-interest to prevent a slowing of the global economy that would further reduce demand for oil.

Iran, however, sees the increased production from Saudi Arabia as an effort to grab market share while Iran faces sanctions. OPEC pumped 31.6 million barrels a day, on average, in April. That was 1.6 million barrels a day above the official production quota set in December. Most of that “excess” production came from Saudi Arabia.

The pre-meeting guessing is that the Saudis will ask OPEC to raise its production quota to 30.7 million barrels a day beginning in July, which would still leave OPEC production above the official quota.

So what’s the point?

An increase in the official quota would give Saudi Arabia more “cover” for continuing to pump at current levels. Global oil consumption typically rises in the third quarter of the year, which marks the end of the refinery maintenance season. It’s unlikely that Saudi Arabia will cut production during that period no matter what OPEC decides.

But an increase in the official quota that is still below what OPEC is producing now would also give the Saudis room to reduce production—voluntarily—in the last quarter of the year—if the global economy is showing more strength. That would allow Saudi Arabia to give its stretched oil industry some breathing room and would bring in more revenue as oil prices rose with even a modest recovery in demand.

So what’s the most likely effect of the OPEC meeting on oil prices?

Stability over the next quarter and a half at something like the $90-$100-per-barrel range (for Brent crude) preferred by Saudi Arabia. And then the possibility of rising oil prices in the fourth quarter of the year—if it looks like the global economy is strong enough to pay the price. (This price scenario would be good news for shares of oil drilling and service companies such as Schlumberger (SLB), Ensco (ESV), and SeaDrill (SDRL). Schlumberger is a member of my Jubak’s Picks portfolio.)

I think this is the likely scenario even if Saudi Arabia and Iran can’t reach any kind of agreement on Thursday.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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