Concerned by the decline of more than 25 percent in the prices of oil in the international market since mid-July, the representatives of Organisation of Petroleum Exporting Countries (OPEC) in their extraordinary meeting in Qatar's capital finally decided to slash output by 1.2 million barrels per day with effect from November 1, 2006.
However, the amount of production that each member would cut was not specified. Also, there was uncertainty over whether Opec would reduce the production from its quota or output levels. Nevertheless, Algeria's Energy and Mines Minister indicated that all the 10 Opec members, subject to quotas, would participate in the cut.
Saudi Arabia was reported to have agreed to slash 300,000 barrels from its daily output. Heads of delegations noted with concern that crude oil supplies were well in excess of actual demand, as the above-average levels of crude stocks in OECD countries demonstrated, and that the imbalance in the supply-demand fundamentals has destabilised the market.
As for future plans, the Opec meeting decided to keep a close watch on crude market movements. Some ministers said that a further cut of 500,000 barrels could follow when Opec next meets in Abuja in December to address high fuel stocks in consumer countries, particularly the US. Supporting the plan to cut supplies, Saudi Arabia's Oil Minister said that "this is not the end of the road".
Notwithstanding the understanding with regard to the output cut, it seems strange that oil prices have not risen perceptibility in the international market. After a small increase, they declined to less than 58 dollars per barrel and continue at about this level. It was rumoured that some of the group's members might fail to comply with the curbs.
There was, in fact, a great degree of skepticism over whether the proposed cuts would be actually delivered. According to the Deutsche Bank, the improvement in Opec's current account positions was expected to limit the degree of production cheating.
All in all, the combination of lower demand and new production from projects being realised around the world, is expected to reduce the need for Opec oil by two million barrels a day before the end of next year's second quarter. Therefore, Opec will not have to only observe the present cuts but act a second time in January if it wanted to maintain the price at around 60 dollars a barrel.
The impact of the Opec decision, seeking to reverse the recent heavy falls in crude prices in an oversupplied market, on the economy of Pakistan would depend largely on the sincerity of its members to observe the stipulated cuts in production and its effect on the prices of oil in the international market.
Since Pakistan meets most of its oil requirements from abroad, a widening in trade deficit during the past two years or so was attributed largely to the consistent increase in its prices in the international market. A decrease in prices would obviously bring about a much-needed relief in the external sector accounts of the country.
Notable, however, is the fact that the prices would have declined more rapidly in the absence of consensus on the output cut by Opec. The likely impact on fiscal deficit, inflation, rate of growth and the level of exports would also be very pervasive and positive. Clearly, it was becoming increasingly difficult for the government to achieve budget deficit targets due to escalating oil prices in the international market and the decision to freeze the domestic oil prices in the past few months.
The government was in fact finding it very hard to honour the price differential claims of the oil marketing companies (OMCs) amounting to Rs 48 billion upto October, 2006. The lowering of the prices in the international market has already enabled the government to pay Rs 28 billion to the OMCs.
A sum of Rs 20 billion is likely to be generated in the next three months by keeping the domestic oil prices at the present levels. Obviously, such a huge amount could not have been raised if the international prices had remained at their peak levels.
Also, the prospects for a decline in domestic oil prices are now very real and this together with a reduction in fiscal deficit would have a softening effect on general prices. Hopefully, the growth impulses in the economy would also get a boost and competitiveness of our exports would improve. Such a scenario, needless to say, would increase employment in the country and alleviate poverty to a certain extent.
However, if the slashing of output by Opec and other factors combine to push up the prices of oil again by a considerable margin, which at present seems unlikely, the economy of Pakistan would again be hard pressed and the policy makers of the country would face troubling times in the not too distant future.