Political Incompetence Could Drive Up the Price of Oil

Includes: DBO, OIL, USO
by: Jim Kingsdale

Oil prices are ascending in concert with a rising stock market and an expanding sense of non-pessimism about the global economy, yet the supply of cheap oil remains far greater than demand. Huge amounts of $5 cost oil is being moth-balled by OPEC and there is no shortage of oil inventory above ground, much of it floating at sea. So the fundamentals of near term oil supply and demand imply lower prices but they are being overpowered by speculators who want to own oil as an investment category.

There are, however, some “green shoots” of real oil shortage. Iraq and Nigeria are both looking dicey. In Iraq security operations for the oil exporting infrastructure will soon be handed over from the U.S. to Iraq, putting them at increased risk. Meanwhile terrorism is increasing on the ground as the “surge” tactics of enlisting Sunni support are being abandoned by the Shiite government. More recently the Kurds announced they are planning to begin exporting oil without Federal permission, not a tactic likely to be accepted peacefully. In Nigeria there are new protests against the government for rigging the last election and for widespread corruption.

Nobody can know if or when oil exports from Iraq and/or Nigeria will begin declining due to these political problems. But in Venezuela it is clear that the time has come when its declining oil production (off 8% y/y) is likely to decline much more rapidly. Pres. Chavez is seizing hundreds of millions of dollars of foreign oil production equipment belonging to contractors who have not been paid and who therefore are withdrawing from their assignments in Venezuela. There’s little question that Venezuela’s state oil company will be unable to keep the flow from declining further without the help of western contractors whom Pres. Chavez has now cheated out of their wages and taken over their assets to boot - as though it were the corporations who are to blame.

Iraq, Nigeria, and Venezuela are three vital oil exporting nations. Problems in those countries stemming from political incompetence could well cause a decline in OPEC output well beyond what is planned by OPEC. If so, the day when a fundamental reason for higher oil prices may come more quickly than is otherwise expected.

All this worth keeping in mind as we observe the oil market - even though it has had little impact to date and may or may not have a great deal of impact for some time. The immediate cause of higher prices now is speculation, pure and simple. Speculation, unlike fundamental supply and demand forces, can turn on a dime, so I would not characterize the current oil price rally as having much predictive power.