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Oil Falls But OPEC Output Boost Raises Questions

The cartel agrees to boost its official production ceiling by 2 million barrels a day.

Updated from 11:15 a.m. EDT

Oil prices fell Thursday, closing below $40 a barrel for the second day in a row, with traders divided over the impact of the Organization of Petroleum Exporting Countries' decision to increase its official production ceiling.

The benchmark U.S. crude dropped 68 cents, or 1.8%, to close at $39.28, after falling about 5.5% Wednesday ahead of the group's meeting today in Beirut. Gasoline futures dropped 4.7 cents, or 3.7%, to close at $1.225 a gallon.

OPEC members agreed to raise the cartel's daily production of 23.5 million barrels a day by 2 million barrels and also announced it would meet on July 21 to consider raising production by an additional 500,000 barrels a day in August.

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Most analysts consider the decision largely symbolic, since the cartel's actual production is generally thought to be at least 25.8 million barrels a day.

"Basically, they're already producing around 26 million barrels a day, so they didn't really do anything, did they?" said Sara Emerson, an energy economist and managing director at Energy Security Analysis, near Boston.

But at least one trader said the OPEC pledge will likely continue the cartel's tradition of producing more than it says it is pumping, and the market reacted to the very real possibility of the unspoken but commonly acknowledged practice..

"I'm in the minority, but I actually think we'll see real oil production go 800,000 to 1 million barrels above what we see now, and that's real oil, not just OPEC talk" said Phil Flynn, head Trader at Alaron Trading in Chicago. "Some of the traders are starting to see that."

Although there were reported divisions among the cartel's 11 members, Flynn said once the decision was made, OPEC members will follow through and meet high global demand.

"They're going to pump every bit they have for the next 30 days," he said. "This has been the most unified front at an OPEC meeting we've ever seen."

The July meeting will prompt OPEC members to deal with their practice of overproduction, and will probably rein it in, he said. That will let OPEC get ahead of market demand and not have to react in its traditionally fractious internal manner.

"Had OPEC acted when prices were above their trading band back at the beginning of the year, I don't think we'd have gotten to $40," he said.

He said comments from key OPEC member representatives telegraphed the decision and influenced the course of Thursday's trading session. The United Arab Emirates. Wednesday announced an immediate increase in production, saying it would add 400,000 barrels a day to the market, while Qatar said OPEC members should produce as much as possible in the next few months to avoid any potential shocks to the market or global economy.

Qatar's oil minister Abdullah bin Hamad al-Attiyah also said the cartel is close to a consensus on boosting production by 2.5 million barrels a day, an 11% increase over its current output of 23.5 million. Qatar and the U.A.E. joined Saudi Arabia in publicly endorsing higher production. Saudi Arabia, the world's largest oil exporter, previously said it would boost daily output by 800,000 barrels a day to 9.1 million, effective June 1.

But Emerson, the economist, said the OPEC decision was less important than the underlying security concerns that are driving the recent price spike.

Weekend attacks on oil industry personnel and facilities in Saudi Arabia drove prices to a record high Tuesday, with the benchmark U.S. crude settling at $42.33 a barrel. Worries about disruptions to supply from the oil-rich Persian Gulf amid strong global demand have repeatedly pushed prices to record highs in the past month. Demand for gasoline has been particularly intense ahead of the peak summer-driving season in the U.S. and Europe.

"The main event in this is worry over the flow from the Persian Gulf," Emerson said. "They could lob a missile into a refinery or a processing station and everything could fall apart. "

She also said Saudi oil minister Ali al-Naimi's comments that Saudi could protect its oil industry were debatable, given the apparent determination of al Queda and other opponents of the government to disrupt its operations.

"What we've learned from 9/11 is that you can take the low-tech option and have very high-value results," she said.