Can Oil Powers Make Cuts Stick?

This week's surprise move to limit production boosts prices, but previous pacts haven't lasted.

Once again, major oil-producing nations are cutting petroleum production to shore up rock-bottom oil prices - and this time they really mean it.

Well, maybe.

To be sure, prices will rise in the short term, say many analysts, but in the end they'll stay low because oil markets are saturated and oil refiners simply haven't been willing to buy more.

"The 1.5 million to 2 million barrel [a day] cuts they're talking about are a mirage," says Larry Goldstein of the Petroleum Industry Research Foundation in New York. "The market would not have accepted that oil anyway."

Still, Mr. Goldstein and most industry analysts regard this week's agreement by Saudi Arabia, Venezuela, and Mexico as significant. By pledging to cut production - and by setting aside their mutual distrust stemming from earlier broken promises - the three major oil-producing nations are demonstrating a fresh resolve to shore up prices.

"All producing nations have reached the threshold of economic and political pain, where any additional drop in the price of crude would have produced backlashes at home," says Mr. Goldstein. Saudi Arabia faced a nearly $15 billion budget cut because of falling revenues, and Venezuela will be holding elections this fall. "Nothing concentrates the mind more than one's own imminent death," he adds.

The agreement, which prompted smaller oil producers in the Middle East to announce that they, too, would ease up on production, may breathe new life into the Organization of Petroleum Exporting Countries (OPEC). In recent years, the cartel's economic and political discipline has seemed to ebb along with the drop in crude prices.

"OPEC needed to change the psychology of the market, and they needed to capture the imagination of the market," says Goldstein. "By including Mexico, a major non-OPEC producer, they were successful."

Get out your wallet

For consumers, the pact means that the days of 80-cents-a-gallon gasoline may be a thing of the past, with prices at the pump expected to rise 5 to 8 cents over the next month. Already, the price of West Texas Intermediate crude has jumped to about$16 a barrel - up from $12.90 last week - and is certain to go higher.

But while this agreement has already talked the oil market out of 10-year lows in crude prices, some analysts say that a number of petroleum nations will still cheat on their quotas to achieve market share.

"Cheating will still go on, but you'll see less of it," says Goldstein.

As news of the agreement spread, Iran, Oman, and the United Arab Emirates said they would also cut production, and even non-OPEC member Norway, the second-largest oil producer after Saudi Arabia, said it would not rule out production cuts. Iraq, which has just begun producing again under a post-Gulf-War agreement with the United Nations, said it would continue to expand production.

While oil prices rebounded Monday after the weekend announcement, some analysts remain skeptical, saying that as prices rise, the temptation to cheat on quotas will become greater.

"The very success of this agreement reduces the incentive for these countries to cut back production," says Ann-Louise Hittle, director of world oil for Cambridge Energy Research Associates in Cambridge, Mass.

Moreover, because OPEC and other oil-producing nations have often cast aside production quotas to achieve greater market share, the market will watch to see if production levels do actually drop before raising prices to the $18 to $20 range that OPEC members are seeking.

A skeptical market

But even if OPEC and non-OPEC members stick to these production cuts, the market is still likely to be careful in its response, Ms. Hittle adds. The proposed cuts are fairly small - about 2.6 percent of the total world demand - and could be rendered meaningless as Iraq ramps up its production.

"Even if they cut back the full amount [in their agreement,] the higher prices might not last that long," she says. "We have that Iraqi output coming on line."

Ultimately, OPEC will have to stick to this agreement if members expect the market to start taking them seriously again, experts say.

"The real issue is do you believe them [OPEC], and will they keep doing it?" says Ed Murphy, an economist with the American Petroleum Institute in Washington. "Quite frankly, if the market thinks this is just temporary, the prices will not bounce back."

For American oil producers, which Dr. Murphy's organization represents, these are particularly hard times. Many small-time producers with marginal oil wells have already stopped production, and last week even major oil companies were starting to cut back on their capital expenditure budgets.

"The US industry is pushed up against the ropes," he says.