OPEC Embarks on a Fool's Mission

Oil has fallen below $70 in the wake of a slowing global economy and massive deleveraging by hedge funds.

Monthly Crude Chart



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When oil was consolidating near $100 I thought that was it. It was plain to see that the global economy was slowing, and it was clear that fundamentals were not in favor of another move higher.

I should have known better, because that is not how trends end. Trends end when every disbeliever (or nearly every disbeliever because my tune never changed) gets religion and hops on the bandwagon in spite of rapidly changing fundamentals. The same thing happened in housing in 2005, and in the blowoff top in 2000 in the Nasdaq, and more recently in various currencies like the Australian dollar and the British Pound.

Indeed, we saw analysts who disliked oil at $50 calling for it to rise to $200 or even $300. People who never heard the term "Peak Oil" before, and probably still do not understand what it means, suddenly found a new religion.

Bulls touting the China story started coming out of the woodwork. The neighbor's kid was telling me about the growth in China. If his cat could talk I probably would have heard about China from the cat.

Pension plans wanting to get in on the commodity boom before it was too late, turned to hedged funds and commodity funds that started rolling over ever increasing numbers of oil futures. This put upward pressure on prices in spite of rapidly deteriorating fundamentals.

Everyone who thought they were a genius simply because they have heard the China story and know the two words "Peak Oil" have hopefully learned a lesson. That lesson is: what everyone knows has long ago been priced in.

Yes peak oil is still a factor, and yes I am a believer in the peak oil theory. However, current demand is a bigger factor in the short to intermediate time frame.

As for here and now, oil prices crashed and that is exactly what they should have done. I steadfastly held to my target of $70 and here we are. Given that global conditions have accelerated to the downside, $50 or even $40 are now likely targets.

OPEC Holds Emergency Meeting

In the face of this steep decline, with oil falling over 50% from the peak, OPEC moves emergency meeting forward.

Opec has moved an emergency meeting to consider a cut in production forward to next week after US oil futures prices neared $70 a barrel.

Abdalla Salem El-Badri, the Opec secretary general, said the cartel had decided to re-schedule an extraordinary meeting scheduled for next month would now be brought forward to October 24th.

Opec on Wednesday said it would need to pump about 31.3m barrels a day in the first quarter of next year to balance the market, well below its current output of 32.2m b/d. The forecast opens the door for a large production cut at the emergency session. Iran, one of Opec’s most hawkish members, on Wednesday reiterated that the cartel should cut production.

Opec, warned of “dramatically worsening conditions” in the credit market and a “negative impact on the real economy”, and Rio Tinto, one of the world’s largest mining companies, signaled that Chinese commodities demand was weakening.

Fool's Mission

Attempting to hold the price of oil up by cutting supplies is a fool's mission. Saudi Arabia and a couple other members are likely to cheat. However, should the cartel be successful in forcing prices up, risks to the global economy will increase. The last thing the world needs right now is a supply shock in oil and/or artificially high prices.

There are those who claim the drop in oil will help consumer consumption. It will do no such thing. Oil prices are falling because the world economy is heading into a recession. Massive numbers of layoffs are coming. The Christmas retail season is going to be a disaster. Falling oil prices are a symptom of that disaster as opposed to a benefit that will support increase spending elsewhere.

Consumers out of a job are not going to increase spending and falling oil prices are just one of the signs that more layoffs are coming. Expect downward pressures on oil prices (in fact on nearly all consumer prices) regardless of what OPEC does or does not do. I am looking for the CPI to go negative within a few short months.

Comments

[solarwindmilli:]

Our country is indeed entering very dark economic times. We need a president/government who will realize the correlation between fuel prices and our rapidly declining economy. One who will put working toward energy independence at the forefront of their agenda. The high cost of imported oil has negatively affected every aspect of our economy greatly contributing to the inordinate loss of jobs and houses. OPEC is planning to cut production again. We have so much available to us such as wind and solar and modern technologies such as hybrid and elec plug in car technology yet we continue to be slaves to imported oil. I am reading a newly released book by Jeff Wilson called The Manhattan Project of 2009. So incredibly enlightening . I wish I could afford to buy every member of congress a copy.

2008 Oct 16 06:31 PM

[Tony Petroski:]

I love these articles on Seeking Alpha. You guys are really smart. But if you have one common trait--along with most of the commentators, you tend to provide analysis that is 10 parts pessimism and 0 parts optimism. Two months ago I was paying $4.10 a gallon for gasoline. Today I paid $2.60. You think an extra $1.50 a gallon in my pocket will make no difference? It already has. I'm also anticipating lower heating bills. I'm consuming more and I'm unemployed.

I'm also anticipating a post-election bounce as the establishment media tells us that all is looking up now that we've done the correct thing by electing Chairman Obama.

Cheer up you Alpha types. This ain't 1929. (Yeah, I know--the Dow didn't recover until 2055).

2008 Oct 16 06:38 PM

[sikarskie:]

We still need to move the margin requirements from 5% to 50% on oil and gas commodities..this is going to stabilize the price structure much more...and not allow huge market manipulations that have occured in the last year. this is a utility ..expect it to be treated as such in the future!!!!!!!!!!!!!!!!...

2008 Oct 16 06:51 PM

[mangolfer:]

It is starting to look like Jason Schwartz (SA author) was right on with his $30 target......

2008 Oct 17 07:45 AM

[Rikiki:]

Michael,

How can you persist in calling "Peak Oil" a theory. When there is a finite quantity of ANY product or resource that is being consumed grand scale, you will have a "Peak XXXXXX" There are capped oil wells in both east and west Texas that reached their peak production prior to 1962. There are entire oil fields in California that reached peak production at mid century. There are regions such as the Permian Basin in west Texas and east New Mexico and Catarell in Mexico which have been in decline for over a decade. And, indeed, there are countries that are pumping less every year. The pool is being sucked dry worldwide. While some field's production is questionable ( i.e. Saudi), others are yet being discovered. Yes, Russia is pumping more and may not peak for some time but Norway and UK have to look forward to a lot less from the North sea platforms.

The point is that you (all countries) have proof that harvesting non-renewable, non-recyclable "stuff" is in decline. There is no argument here, scientific or otherwise, to dispute this "law of use and depletion of non-renewable resources". So it is not a theory. It is provable!

AGW, on the other hand, has hundreds of variables, modeling and outright guessing based upon short historical patterns of climate. There is no "proof" one way or the other that global warming is anthropogenic. I believe most in the field of climatology simply say there is no proof. Therefore, like Einsteins Theory of Relativity, AGW will remain a theory.

Proof, Michael.


Rikiki

2008 Oct 17 09:09 AM

[john s. gordon:]

yes commodity speculation on 5% margin is contrary to good public policy.
> jack

2008 Oct 17 09:33 AM

[bosunj:]

Tony Petroski: Rah rah rah sis boom bah! We're number 1, we're number 1, go team go, rah rah rah sis boom bah. Obviously you are a true believer! I got a tip for ya! Buy K-Y, you're going to need it!!

2008 Oct 17 09:56 AM

[bosunj:]

mangolfer: ge Jason's johnson out of your mouth and wipe your chin!

2008 Oct 17 09:58 AM

[NOWHEREMAN:]

So what you are saying is that the Oil producers should sell oil at prices which will destabilize their economies just so the Developed world can enjoy this benefit?

Current Middle East Projects will Cost roughly $500 Billion a year for the next 15 years. Interupting them may destabilize the Countries that produce the oil because of promises made to the populace.

The developed world is reaping the Benefits of the US created Financial Crisis. Why should other countries feel the same pain.

2008 Oct 17 11:07 AM

[yank:]

$30 oil is a pipedream. We will see massive cuts in oil E&P capex before that happens. I am not an OPEC defender but simple economics is tellng you today that the world needs LESS oil, not more. So it is quite logical for OPEC to produce LESS oil, not more, global recession or not. Many oil companies cannot earn profits with oil below $60. Look at Suncor, the largest operator in the Canadian oil sands. They have already indicated that they will cut production significantly if oil goes below $70 and stays there. The saudis and other mideast countries are in the middle of massive CAPEX projects to expand oil production and refining. Many if not all of these projects are so costly with high labor and materials that they are not viable with oil below $75-80. They will simply stop these projects in their tracks before they lose money. The days of cheap oil are gone forever. Think our production will catch up to demand? Think again. Russia, Mexico, and Norway, three of the largest oil exporters in the world have all reported significant DECLINES in production year-to-date. I guess only the geologists and petrochemical engineers are smart enough to understand the importance of oil to the global economy. There simply is no viable, economical substitute for oil right now. Period.

2008 Oct 17 11:52 AM