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Opec actions speak louder than words

LONDON - If Saudi Arabia wants to stabilise oil prices and dampen volatility, the kingdom will have to back its verbal commitment to a target of $70-80 per barrel with adjustments in production. Verbal interventions alone will not be enough to anchor expectations or market prices.

Back in November, Saudi Oil Minister Ali Al Naimi welcomed the reduction in price volatility over the last 18 months and claimed “There’s almost an anchor now for the price.”

Saudi officials admit there is no fixed band for prices and expectations management on its own is not enough to stabilise the market.

Nevertheless, fostering convergent expectations among producers, consumers, financial institutions and the media is a crucial part of the kingdom’s strategy for avoiding a repeat of the destabilising price spike and collapse experienced in 2006-2008.

But in a thoughtful paper subtitled “Fair Price Pronouncements and the Market Price of Crude Oil”, Bahattin Buyuksahin and other researchers working at the US Commodity Futures Trading Commission concluded pronouncements by OPEC members including Saudi Arabia about fair prices have little influence on actual prices, and supply little or no news to market participants.

The authors focus on 63 separate occasions between 2000 and 2009 in which members of the organisation have made reported statements about what the “fair price” of oil should be — of which only 13 coincided with production-related announcements by OPEC.

Of 63 pronouncements, only five appeared to endorse prevailing price levels, 24 explicitly disagreed, and in most of the remaining 34 cases officials appeared to disagree at least implicitly. In most cases officials thought prices were too high, blaming speculators. But in 2008 and the first half of 2009, officials generally thought prices were too low, and continued to insist fair prices were in the $70-100 range despite the collapse of futures prices.

The authors found no evidence price pronouncements have any discernable impact on subsequent futures price movements. Price pronouncements “are not successful at either affecting the direction of the market or at slowing down the pace of prior movements,” they wrote. In fact, the authors are unable to reject the hypothesis the fair price is merely a lagged function of market prices. “Visually, we show that the ‘fair price’ series looks like a sampling discretely drawn (with a lag) from the daily market price series” a conclusion supported by a battery of formal statistical tests.

OPEC’s definition of fair prices apparently responds to market prices rather than the other way around. As market prices go higher, OPEC’s definition of the fair price rises with them.

The authors show fair price pronouncements do not contain any news not already been incorporated in prices through prior market expectations. It comes as no surprise participants do not respond to statements by traditional OPEC “hawks” (Algeria, Iran, Libya and Venezuela). These countries are thought to be most bullish on prices, though the authors find limited evidence of this in practice. But they have little spare capacity, tend to pump maximum output and have poor compliance records, and therefore have little impact on actual supply, so most market participants disregard them.

Surprisingly, though, the authors found pronouncements made by swing-producer Saudi Arabia and other cartel members were no more influential. The authors’ statistical work supports the existing market consensus: deeds rather than words are what matters.

Although the authors do not say this, the implication is that Saudi Arabia’s pronouncements will influence expectations only to the extent that market participants think they will be backed up by actual output changes.

It is the expected production adjustments — not the publicly announced price targets — which affect prices. Public pronouncements are neither necessary nor sufficient to influence the market. That would be consistent with 2008, when prices started falling from late July, shortly after Saudi Arabia announced a production increase following the Jeddah summit, reversing a previous policy of resisting output increases and blaming speculators for unsustainably high prices.

Like some central bank officials, Saudi Arabia may be over-estimating its ability to influence expectations and ultimately prices by jawboning the market. Attempts to dampen volatility by announcing a public price target may be doomed to fail unless it is given operational content with a commitment to vary production levels. It is Saudi production decisions rather than verbal price targets that influence expectations and price levels.

In the last two months, Saudi Arabia has refused to lift its output, even though prices have risen significantly above its stated target range. Oil market bulls are betting the kingdom will not lift output even if prices break through $90 towards $100, and seem keen to test Riyadh’s resolve in 2011.

Sooner or later, the kingdom’s policymakers may be forced to back up their verbal intervention with a credible commitment to increase production (linked to market prices rather than inventories) if they want to stabilise expectations and prices around the $70-80 or $70-90 range.

Reuters

(John Kemp is a Reuters market analyst. The views expressed are his own.)