Opec changes strategy (page 3 of 3)

A lack of absolute refining capacity in the OECD, and appropriate capacity in India and China are key issues that support sustained higher prices for high quality crudes.

OPEC's price aspirations are opaque

OPEC's USD22-28pb target price band, which was introduced in March 2000, has been largely defunct since early 2004, and was officially suspended in January. There are three key arguments for a higher target. First, OPEC's purchasing power has been eroded by USD weakness.

While the OPEC basket has risen 79% in USD terms since March 2003, it has risen only 31% in EUR terms (see 10). Second, while specific countries are suffering, high oil prices have yet to have a significant detrimental impact on global growth.

Third, with hindsight, industry investment rates have been insufficient in meet future demand. However, to date OPEC has not agreed on another target band, and conflicting and unclear messages from members are adding to price volatility.

Price forecasts

We now believe WTI will move in a USD40-50pb band this year, averaging USD45pb. Rising global stock levels will alleviate concerns and allow prices to ease from current levels.

Prices will stay more volatile than pre-2004 as OPEC has lost the ability to micro-manage the market. We are raising our forecast for WTI in 2006 to USD40pb as capacity growth has not accelerated sufficiently to alleviate the market tightness over this period.

The key risk to this forecast is a sharp decline in global growth. It is inevitable that oil demand growth will ease at some point. The critical issue will then become OPEC's ability to manage itself, given the change in relative production capabilities. On current evidence that crunch is not going to come until beyond 2006.