Harmony seems to have returned to the cartel for now

Following an acrimonious meeting last June, OPEC met again this week. In an unusual display of harmony, the cartel agreed to a 30 million b/d production ceiling for 1H12, including Iraq. This target is based on OPEC's view of global demand for their crude, and there was no mention of a hard or soft price band, or individual country quotas. OPEC unusually emphasized a targeted inventory build of 650 thousand b/d in 1H12, a figure in line with our own expectations. This is an important wrinkle in policy, as oil price stability has historically been OPEC's focus. As stocks build, OPEC's agreement reinforces our view that Brent and WTI prices will fall to an average of $100 and $92/bbl, respectively, in 1Q12.


OPEC will allow a stock build to prevent another oil spike

OPEC's focus on stocks may be partly driven by demand uncertainty and rising geopolitical tensions, as price elasticity of demand in the oil market is very low. A 1% demand contraction typically requires a 20% increase in oil prices, and vice versa. Thus, the collapse in global oil demand in 2009 resulted in a 40% drop in prices, while the Libyan civil war likely added 20% to oil prices this year. Given this background, it is worthwhile highlighting that Iran exports about twice as much as pre-war Libya did. So oil prices could increase by $40/bbl should Iranian output completely shut down, a key risk to our negative outlook. A potential closure of the Strait of Hormuz could result in a much faster oil price escalation.


Saudi influence will grow as OPEC heterogeneity increases

At any rate, the degree of OPEC cohesion, measured by the rolling correlation of key cartel members with Saudi production, has fallen. With 2012 break-even price for OPEC government budget balances as high as $172/bbl in Venezuela and as low as $65/bbl for Kuwait, the cartel is becoming an increasingly heterogeneous group. For this reason, Saudi influence will likely continue to grow. Should oil demand fall unexpectedly in 2012, Saudi will likely be forced to lead supply cuts. Willingly or not, Iran and Venezuela, just like the rest of the world, are becoming more and more dependent on Saudi Arabia's ability and willingness to stabilize oil prices.

source: Bank of America ML