More Later: OPEC Will Have to Boost Oil Production Soon By Christopher Edmonds Special to TheStreet.com 6/5/01 2:57 PM ET

For OPEC it's a question of when, not if.

While the first day of the Organization of Petroleum Exporting Countries, or OPEC, meeting didn't yield more crude oil for the rest of the world, the rhetoric pointed to increased production from the cartel in the coming months. And, with Iraq's defiance of current United Nations standards for exports cutting up to two billion barrels of exports a day in the headlines, OPEC may be persuaded to pump crude more hastily than originally thought.

"It seems fairly evident that a production hike will be necessary in the near future, the pressure for which intensifies should Iraqi exports remain absent for a protracted period," noted Merrill Lynch analyst Michael Rothman in a dispatch from Vienna Tuesday morning.

Iraq hinted late last week that it would discontinue exports under the current United Nations Oil-for-Food program, potentially removing up to 2 million barrels of crude per day (mb/d) from international markets. Estimates suggest the bulk of that oil found its way to Europe and the U.S., about 700,000 barrels per day to each.

While Iraqi leader Saddam Hussein is infamous for playing politics around OPEC events, most think the current withdrawal from international markets may last. Hussein is showing increased resolve to withhold exports until U.N. sanctions are lifted. "Iraqi exports are likely to be out of the market much longer this time than last," analysts at UBS Warburg concluded in their morning note to clients on Tuesday.

While the impact of Hussein's decision won't have an immediate impact on oil supply, OPEC could be forced to address the issue if it lingers. So concerned about the potential impact on supply is OPEC that it has tentatively scheduled a special meeting for July.

Without supply from Iraq, OPEC's economic tightrope was raised higher off the ground. While oil-producing nations are concerned that adding additional production to the pipeline too soon would cause oil prices to dip, withholding supply could push prices higher, worsening the global economic slowdown and pressuring demand.

"While ministers fear creating an oversupply situation, they seem equally nervous about allowing the oil balance to become overtightened and having oil prices slingshot well above the $30 level, potentially exacerbating the current economic downturn," notes Merrill Lynch's Rothman.

So far, the price response to Iraq's decision to withhold oil has been minimal, a result of the market's expectation that OPEC will make up the difference if Saddam's intransigence continues. In addition, crude supplies around the world remain slightly higher than this time last year, suggesting demand has moderated as the economy has weakened.

However, if the Iraqi supply is removed from the market for an extended period of time, the draw from storage will become noticeable in the coming month, possibly pushing prices above the $30 mark, well above OPEC's $25 target price and outside OPEC's $22 to $28 per barrel price band. OPEC's automatic trigger would allow for increased production if oil remains above $28 per barrel for 20 days.

However, some analysts expect OPEC to be more proactive, concerned that higher oil prices would further damage a fragile economy, causing demand to drop and prices to tumble well below the $25 per barrel target price. "This time, we think OPEC might be pro-active on the upside, waiting until prices move up but not waiting the full 20 days," the UBS Warburg report suggests. "Higher prices pose a risk of more demand erosion and a faster shrinkage of OPEC's market share."

Even without Iraq's withdrawal from the market, it is likely OPEC will consider a production increase this summer given lower storage projections into the second half of the year. While Rothman says there is little consensus on the level of increase, he projects an increase of 1.5 mb/d, saying it "seems warranted," sometime this summer.

If OPEC concurs and Iraq remains out of the market for an extended period of time, that would mean an OPEC increase of more than 3 mb/d, pushing OPEC's current production capacity. "A combined quota hike of both of these volumes [the 1.5 mb/d plus the shortfall created by Iraq] would exhaust all but Saudi Arabia's spare production capacity," concludes Rothman.

Short-term, such an increase in OPEC production should push prices closer to the $25 per barrel target. However, longer-term, an economic resurgence that increases demand for crude could strain OPEC production capacity and hence, push long-term prices higher.

Such a scenario would highlight the need for more non-OPEC production and highlight the oil-focused exploration and production companies as well as the integrated oil companies like ExxonMobil (XOM:NYSE - news - boards), Shell (RD:NYSE - news - boards) and BPAmoco (BP:NYSE - news - boards). Such a move would also give rise to calls for more drilling rigs, providing a potential lift to the oil service names.

And, it would let Hussein believe he has OPEC and the United Nations over a barrel.

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