OPEC's Pity Party: Portents for the Global Economy

By Julian Murdoch

OPEC has been insisting that the oil market is oversupplied for months, and at its heavily anticipated emergency meeting last Friday, instigated by crude prices that have dropped over 50% since summer, they finally did something about it. A reduction of 1.5 million barrels per day (bpd) will take effect on Nov. 1 - effectively cutting OPEC's production by around 5%.

How did the market react?

 Oil prices dropped a coincidental 5% as well. Perhaps traders were expecting more? Or perhaps the slide we're in right now is too powerful to be stopped by the announcement of an ineffective cartel on an otherwise-average Friday in Vienna.

The Buildup

In the days leading up to the meeting, pundits estimated that OPEC would cut production between 1 million and 3 million bpd, with lots of talk of what an "acceptable" price range for oil would be. Each country in OPEC has its own ideal price range, directly related to how much of their economy (and more importantly, their government budget) relies on oil revenue. Nigeria, for example, is heavily dependent on oil revenues, and last week, Odein Ajumogobia, the Nigerian oil minister, drew his own line in the sand:

Nigeria would be comfortable to have the oil price at $80 in view of the production cost and in view of the fact that Nigeria is looking for more money to finance its budget.

He also confirmed that the country had changed its draft 2009 budget to reflect a benchmark oil price of $45 per barrel instead of the $62.50 per barrel it contained originally. That's a big change that's going to lead to a lot less government spending in a country that is fairly unstable already.

Iran, in its classic role of price hawk, had called for cuts of 2 million to 2.5 million bpd in the days leading up to the meeting. This could be because it is estimated by the International Monetary Fund that Iran needs oil at around $110 a barrel in order to meet its own budgetary needs.

And then there is Venezuela and Crazy Uncle Hugo, whose socialist programs rest almost entirely on the back of oil revenue. Reuters reports that some analysts believe Venezuela needs oil around $100 per barrel to support the government's spending, but Mr. Chavez recently disputed that number, calling for a price band of $70-$90 per barrel.

As usual, Saudi Arabia was the country that we were all really looking at, because Saudis still drive the OPEC bus. They were the ones that had upped production when prices were high, even though OPEC kept saying the market was oversupplied. Saudi Arabia is also where the largest cuts would have to come from, in any case.

Budgetwise, Saudi Arabia is sitting pretty. Its most recent budget apparently is based on the assumption of oil at around $50. The country has the largest oil reserves, and is well-served by prices remaining high enough to meet their budget requirements, but low enough to discourage the search for alternative fuels or (gasp) pure demand declines. But even Saudi Arabia didn't like the direction oil prices were headed and the speed at which they were falling, so they agreed to the production cut.

Here's how the cuts shake out for each country, in non-barrels per day:

Algeria	71,000
Angola	99,000
Ecuador	27,000
Iran	199,000
Kuwait	132,000
Libya	89,000
Nigeria	113,000
Qatar	43,000
Saudi Arabia	466,000
U.A.E.	134,000
Venezuela	129,000

 Saudi Arabia and Iran will see the largest reductions with U.A.E., Kuwait and Venezuela next in line.

How this will affect the market is anyone's guess.

Oil demand in the U.S. continues to fall. This can be seen in the crude inventory numbers reported by the Energy Information Administration, which rose again last week. It can also be seen in the August driving numbers reported by the U.S. Department of Transportation.

In August 2008, Americans drove 15 billion fewer miles, or 5.6 percent less, than they did in August 2007 - the largest ever year-to-year decline recorded in a single month.

Over the past 10 months, Americans have driven 78 billion fewer miles than they did in the same 10 months the previous year.

Falling oil prices means falling gasoline prices at the pump, which could lead to an increase in driving miles if the economy were holding steady. In these days, that logic may not prevail.

An interesting thing to note is that the price of gasoline in the market is lower now than the last time we had oil at these prices.

The last time oil was at this level was summer of 2007 - a time when the price of RBOB (reformulated blendstock for oxygen blending) gasoline seemed decoupled from the price of crude. Since then, however, the coupling has been much stronger.

More Cuts Ahead?

OPEC has not ruled out further cuts if prices continue to fall; in fact, Forbes reported that OPEC President Chakib Khelil told a press conference:

If a further decision has to be made, it will be made and we will not necessarily wait for the Oran meeting.

The next scheduled meeting for OPEC is in December. We'll see if we make it that long or if OPEC tries to flex its muscle again in an attempt to stop the price plunge.

Comments

[Jason Rines...:]

Like most producers of anything, they are looking for the maximum price consumers will pay for a product. $147 was far too high and caused a market crash in June. At $80 and $3.00 gas, consumers and companies seemed to absorb the cost and adust. But of course, that was before the market crashes based on excess liquidity. I believe we'll see $80 a barrel and then higher by the second quarter of 2009 and it will inch higher from there. While I normally blame the exhorbitent price on OPEC, you can squarely put the blame on Washington whom has not made many friends globally. I do speak with others overseas, they all say the same thing that they love America but hate our government. You can add me to that list.

2008 Oct 27 02:26 PM

[blackbody:]

I think we can now say that the rise in OIL price from $70 to $147 in 10 month period was not due to consumer demand, but rather due to speculative demand. Therefore it is no coincidence that OIL is tanking as global deleveraging is underway. Likewise, the so called demand for steel, corn, wheat, and most likely all hard assets, were driven by speculative demand rather than consumer demand. Therefore then what does CFTC have to say for their explanation of OIL price? Are these regulatory agencies run by idiots or criminals, or possibly both?

2008 Oct 27 02:37 PM

[OilyGasMiner:]

blackbody,

the regulatory body IS run by both criminals and idiots. Fundamentals have NOT changed, only the "perception" of fundamentals. Which is trickled down through the reg. agencies.

Speculation is simply a premium on top of fundamentals. But when the reversed occurs, we see manic conditions as existed in our current economy. The question is. How do we capitalize on the current market?

2008 Oct 27 02:46 PM

[blu:]

This economic emergency will not derail the continuing need for hydrocarbons. I am sick of hearing everyone pointing their finger at someone else and trying to find someone to blame.

The market will determine what a fair price is. It is going to be lower for only a short time. We have reached peak oil. This current drop in demand will lower prices for a while, but the depletion of the resource will continue at a very rapid pace. Consumption will start picking up due to lower prices and thus, the price will escalate again.

Consumption in Texas has already started expanding. There are lines at the gas stations trying to buy the cheaper gasoline. People are going to be driving more.

It's not that the public hasn't learned from the past. It's the fact that the public is willing to pay more.... !!!

2008 Oct 27 06:21 PM

[jadziasman:]

Peak (cheap & easy to recover light sweet) oil has been reached, yeah.

The Earth's atmosphere will rival Venus' before humans have completely exhausted all available fossil fuels. King Coal will ascend to the throne once again. Nanotech will make it possible to convert the dirtiest coal into clean fuel.

Tar sands, oil shale, you name it have and will become the fuel sources of the future.

Peak? Heck, it's not even the end of the 1st quarter yet.

2008 Oct 27 07:11 PM

[Turt:]

Until a viable alternative to oil is found the demand and therefore consumption of Oil will continue unabated.
Alternative and clean energy technologies are still nascent and not cost effective. Its only when the price of Oil rises that the incentive to develop and commercialise alternative energy technologies gains speed. The spurt in price to $147 a barrel of oil has acted as a wake up call and encouraged funding and research on alternative energy sources.

I agree with Jadziasman that Coal might be the big surprise in 2009. It is available in abundance and Coal washing and Clean coal technologies have come a long way.

2008 Oct 28 10:11 AM