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OPEC Gets It Right

Christopher Edmonds

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.

At least for the next two months, OPEC may have helped push crude prices higher without any reduction in overall crude supply. If that happens, the cartel's rhetoric could once again prove more important than its actions.

Stock Talk

OPEC's actions helped boost energy equity prices on Thursday, and the price performance of the majors was no exception. Exxon Mobil (XOM Quote), Chevron (CVX Quote) and others all benefit from a more bullish outlook for crude prices.

So, too, should large service companies such as Halliburton (HAL Quote) and Schlumberger (SLB Quote).

However, the warm weather of this week and likely next may pressure these stocks in the short run, especially if both crude and natural-gas inventories turn bearish in the near term.

Yet, assuming a more normal winter -- combined with OPEC's bullish action -- a pre-Christmas dip in energy equities may well turn out to be the best present of all.