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Fri 19 Dec 2008 12:42 PM

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OPEC must deliver on cut to stabilise prices

Scale of cut enough to turn around market eventually if OPEC exercises full restraint, analysts say.

OPEC must deliver fully on its promise to tighten supply by a record amount if oil prices are to stabilise above $40 a barrel and eventually return to much higher levels.

The 12 members of the Organization of the Petroleum Exporting Countries vowed on Wednesday to remove 2.2 million barrels per day (bpd), starting in January, to halt a $100 price collapse from a July peak.

"The proof of OPEC's pudding this time really will be in the eating," said Simon Wardell of Global Insight. "If OPEC can implement the cut it is promising, then oil prices will recover over time. If not, then it is quite a different scenario."

A worldwide recession has battered demand for fuel and pushed oil on a five-month downward spiral.

For the first time in decades global oil use is shrinking and there is a surplus of supply over demand, particularly on the margins of the market which determines the price.

OPEC responded only slowly initially to the mounting stockpile in the market and trimmed its output by only 500,000 bpd in September. In October it took more dramatic action, cutting by 1.5 million bpd.

The market still felt OPEC was behind the curve and prices fell from around $100 a barrel in September to closer to $40 at the beginning of this week, near four-year lows.

OPEC has been even bolder this week with a cut that lowers production by 4.2 million bpd from September levels.

The initial market reaction was negative and US benchmark crude fell below $39 a barrel on Thursday.

Analysts, however, said that scale of cut should be enough to turn around the market eventually if OPEC exercises full restraint. They see demand for OPEC crude running above its new output ceiling of 24.845 million bpd.

Even OPEC realises the market will not turn around soon.

"The purpose of the cut is to bring the market into balance and avoid the gyrations of the price," Saudi Oil Minister Ali al-Naimi said on Wednesday. "The cut may lead to higher prices or may not."

"Provided these cuts materialise, output would be reduced by around 4 percent of current world demand. This would be market supportive, especially in view of declining exports from Russia," said Andrey Kryuchenkov of Russian bank VTB.

The problem for OPEC would be enforcing cuts which would be especially painful for those members faced with budget deficits as a result of the collapse in oil revenue.

OPEC's biggest producer, Saudi Arabia, would bear the brunt of the new cuts, reducing output by more than 1.3 million bpd from September to just above 8 million bpd.

Iran, the group's second biggest producer, would have to cut 564,000 bpd from September levels and Venezuela 340,000 bpd.

Both countries are under intense fiscal pressure as they require oil prices well above current levels in order to balance their budgets and both have been accused in the past of not meeting all their obligations when given lower output quotas.

According to independent observers cited in OPEC's monthly report this week, the group's compliance in November to existing cuts was only just over 50 percent.

"Unfortunately for OPEC it has a history of non-compliance," said analyst John Hall of John Hall Associates.

"And with the view that only around 65-70 percent compliance can be claimed so far on the cuts announced in September and October it is unlikely that the market will initially treat this additional cut any less seriously."

But if OPEC can fully enforce its latest cut, analysts say it should tip the supply demand balance and prices should rise.

Short-term pain should produce long-term gain, they say.

British investment bank Collins Stewart said the new OPEC output target was below its estimate of the expected call for OPEC crude and so should tighten the market.

"Although the market remains highly sceptical, we think it underestimating the determination of OPEC to underpin prices, and we expect the hard evidence of this determination to emerge in the next few months," it said in a note to clients. (Reuters)

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