OPEC Gets It Right

This time, OPEC may have it right.

The oil cartel's decision Thursday to announce the possibility of a 500,000-barrel-per-day production cut beginning in February may turn out to be moot. It may also be one of OPEC's best price-management jobs ever.

The Organization of Petroleum Exporting Countries (of which one member, Indonesia, is actually a net importer of crude oil) said it would cut collective production on Feb. 1 if oil remained below $60 a barrel. That price -- measured by the OPEC crude basket, which is usually $4 to $5 below the Nymex price -- appears to be the cartel's new litmus test.

If oil prices rise above $60, OPEC will probably just quietly forget about the proposed cut and keep producing oil at current levels.

Head Fake

While crude inventory levels may appear slightly above historic norms today, storage levels of gasoline and distillates, including heating oil, seem relatively tight. As a result, normal winter weather will likely help increase product demand enough to push the price of the OPEC crude basket back close to, if not above, $60.

In addition, geopolitical events may very well again begin to have an impact on oil prices as we enter 2007. If that happens, $60 could be in the rearview mirror come February.

That said, OPEC's rhetoric sends a new and compelling price signal to global energy markets. For the first time since abandoning the $22-to-$28 price band nearly two years ago, the cartel signaled its expectations. While it could be difficult to hold that price objective, OPEC's message is likely to have a meaningful -- in this case, bullish -- impact on crude prices in the coming months.

The potential for a production cut could be enough to keep crude prices around $60. If, for some reason, crude doesn't hold the "magical" $60 level, then production cuts in February will likely boost the price. Either way, OPEC's move should keep prices at or near current levels through winter.

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At time of publication, Edmonds was long Exxon Mobil, although holdings can change at any time.

Christopher S. Edmonds is partner and managing director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.