OPEC's Cuts Can't Fight Global Recession Headwinds

OPEC has decided to reduce oil production by 1.5mm barrels per day from its current quota of 28.8mm barrels per day. At the writing of this article, December Crude is down $3.36 (-5.21%) and trading @ 64.59.  Concerns of a global recession far outweight the demand for energy as the Center for Global Energy Studies estimates that global demand will fall in 2008 for the first time in 15 years. Its U.S. counterpart, the IEA, also concurred last that demand growth is contracting.

OPEC members may find themselves in a Catch-22 scenario. Cutting production to support prices during a financial crisis could weaken demand even more. Then again, its members may also be inclined to cheat on their quotas in order to compensate for the reduced revenues caused by lower prices.

Technically, oil has broken through its 200-week moving average and appears headed to test its January 2007 support level @ $50 per barrel. On an intermediate time frame, resistance is @ $70 per barrel.

For a more detailed analysis, please see Rachel Ziemba’s analysis at RGE Monitor.

Disclosures: None

Comments

[Greg Pinelli:]

This is another of the short on real understanding articles one gets on Alpha. OPEC members (read Saudi Arabia)..can afford to sit on reserves that make up a DIMINISHING resource pool. In six months the world monetary system will be awash in credit and cash..and oil will have constinued to towards ultimate depletion. So YOU tell me whose playing the strong hand??
Buy oils (and nat gas) RIGHT NOW. Guys like the auther couldn't make rent money with their analyses..or recommendations.

2008 Oct 24 08:53 PM

[Ferdinand E...:]

The large oil exporting countries have had a good run, and they expect the same experience in the future. I just hope though that they don't try to make too much of a good thing when the oil price starts up again. It's in their interest as well as the interest of the oil importing countries if we see a little cooperation between buyers and sellers. And, since ignorant busybodies like Milton Friedman are not around any more to fill the heads of our political masters with nonsense, it may be possible.

Of course, certain things have to be understood. There is a shortage of
oil in the crust of the earth, and that reality won't go away regardless of what happens to the oil price in the near or the distant future. Clearly, people like the next president of the U.S. will need their wits about them during the next decade, because at the end of that period the bad news about oil - and perhaps also gas - will be there for everybody to see.

2008 Oct 25 08:45 AM

[mangolfer:]

It appears to me that the oil bottom has yet to be seen. I believe Jason Schwarts (SA author) was right about $30 oil coming. Maybe long term (and I mean LONG) oil will come back to the $70 range, but there is alot more interest in stopping a recession right now. Spending $100 to fill your tank does not help stop a recession.

2008 Oct 25 09:32 AM

[satch63:]

OPEC members have an interest in keeping a share of the energy market. Crude oil in the less than $70 range will discourage alternative energy development therefore do not be too happy about lower prices.

Crude oil in range of $80 makes tar sands and alternative energy sources possible.

Demand is now down but the battle for long term reasonably priced fossil energy sources will continue.
Lower prices mean the public companies will pull back and the nationally owned companies (China, India, Russia) will continue pursuing energy for the future and public companies will take second place.

2008 Oct 25 09:47 AM

[MudEngineer:]

If Mangolfer is correct about $30 oil, it will not be there for very long. That price is below the production costs in the Gulf of Mexico and would cause many marginal production platforms to be shut in. Exploration would fall dramatically and create the next major oil shortage in coming years. Even the possibility of Obama being elected and reenacting windfall profit taxes that failed dramatically in the 1980's is making some oil companies curtail exploration. The next shortage will make $150 oil look really cheap. Even less supply and greater demand than the present. Bad combination. Be very careful what you wish for.

2008 Oct 25 11:21 AM

[Paul Killinger:]

Fred,

Of all the inane comments I've ever heard on SA, your calling Dr. Friedman an "ignorant busybody" EASILY takes the cake. May I suggest you not make another ridiculous comment (or invest another dime) until you learn at least a little more of what you're talking about. If it weren't for this insightful gentleman, the U.S. would have long ago ceased to have an economy worth worrying about.

In the next few years you're going to get to see the value of a Keynesian renaissance close up. You know, "change we can believe in" as a result of "spreading the wealth around." Any investor with any sense should be running for the hills about now, as the S&P already demonstrates.

Let's talk afterwards, and see if any investment (outside of gold, possibly)survived.

2008 Oct 25 11:22 AM

[Timothy Stolz:]

Let us suppose that the accepted rule of supply and demand exists. That supply being more than the demand, as measured in a given quantity by the Center for Global Energy Studies and/or the US equivalent, the IEA. That demand is now measured to be contracting in 2008, for the first time in 15 years.
Now OPEC comes into the equation with a "stated" and who knows if "real" factor decreasing the supply by 1.5 mbd, that likely will only offset the equation by a portion of the decreasing demand.
At some point in time the OPEC decrease and the steady augmentation of the demand destruction component towards neutral or zero, should occur.
As measured in the beginning of OPEC's involvment in our equation, they really had no impact on the price of oil, cheating or not cheating. As the reduced demand component moves closer to neutral, in theory, OPEC begins to have an influence on the price of oil. In other words, "until the slack is drawn up in the rope, you can't make a noose." That slack is the reduced demand component of the oil price equation too large for OPEC to alter by their recent stated reduction. Maybe later when the demand catches back up with the supply they will have more of an ability to control prices.

2008 Oct 25 11:33 AM

[Paul Killinger:]

Way back in the 19th century, a famous French writer named Alexis deToqueville extensively toured America, and wrote about the coming social and economic miracle he witnessed firsthand. He opined that this great democratic experiment would thrive until its citizens one day realized they could vote themselves "the proceeds of its Treasury." Well, it took us 150 years, but we've finally managed to do it, friend.

2008 Oct 25 11:35 AM

[ldker:]

I have to say you have to think logically about oil price - this is a rubber band snap back to the extremes of 147 oil brought on by the single most important thing people seemed to be less focused on = hedge fund deleveraging. At some point this deleveraging will stop and we will see oil be back up beyond 70 - I am not saying it won't over shoot to the down side into the 50's, but to feel confident that it will stay in that range for anything but a short amount of time is hard to believe. 4 months ago we were at 147...should Hummers come back in style and run over the smart cars now??

2008 Oct 25 12:30 PM

[Paul Killinger:]

I would agree. In past downturns of this severity, we'd be talking about $20-30 oil by now. So it appears there really IS a new supply and demand equation this time.

And while there may be something of a rebirth for the Hummers and their peers for awhile, it will only last until demand begins to outstrip the supply of oil again.

Our only hope for reasonable long term oil prices is the Pickens Plan. Once you begin to erode demand for oil at the margin, you may be able to succeed in prices not going completely out of sight.

We'll see.

2008 Oct 25 01:45 PM

[Paul Killinger:]

It's also likely that the bulk of our undicovered domestic reserves are NG, not oil. This makes it all the more important we begin the transition away from Black Gold as our primary transportation fuel.

2008 Oct 25 01:50 PM

[mkreisel:]

Oil will not stop dropping until some bigwigs are wiped out. It could be Rogers, and that would be the ultimate punishment for this traitor.

2008 Oct 25 04:01 PM

[sickofthehype:]

Spending $100 to fill your tank doesn't help a recession, but inflating our way out of the recession will help $100, or $150, per tank, become reality.

Inflation is right around the corner, so any price hits will be short lived.

It's funny how when oil was being hyped up over $100 you would hear daily about someone predicting $125, then $150, then $200, then $250! And now that we're well under $100, all you hear are predictions of $75, then $70, then $50, and now $30. I predict FREE oil!!!!!!

It's ridiculous. If any of these 'experts' could predict anything remotely close - they'd be living on their own island somewhere.

We seem to have short term memories out here in la la land. Oil will rise due to the dollar 'rally' ending with inflation out of control.

2008 Oct 25 09:03 PM

[FourBrane:]

Friday's drop in oil has to be seen in context: EVERYTHING has been dropping worldwide. Oil paid no attention to OPEC nor is it mechanically responding to supply or assumed demand destruction because the broader context is VALUE destruction. Market-wide, normal valuations (PE, etc) mean almost nothing. None of us are comfortable buying anything at any price (oil, gold, or grain) until we think we might actually have a chance to figure out the game.

Under these conditions, oil may momentarily drop to $30 and diamonds sell for the price of glass. The craziness probably won't end until at least the Japanese carry trade has been totally unwound and probably when most hedge funds are belly up with nothing left to dump.

The market is already pricing as though no one will ever drill for oil again. There are oil service companies selling at PEs below 2 right now. Their market values are below the fully depreciated replacement cost of their equipment...never mind other aspects of their usiness. Tellingly, even these companies can't be snapped up on the cheap because no one can borrow a dime.

It won't last. Without exploration, the price of oil will have to climb as pumping rates slowly decline. Peak oil is real and peak world population is nowhere in site.

2008 Oct 26 04:49 AM