Oil Drops - But OPEC Looms

Analysts are trumpeting the recent drop in oil prices as a step toward normalcy. But is this celebration premature? Or perhaps even misplaced?

After all, we all know that over the long haul, energy prices are headed in only one direction - higher.

Crude oil plunged 8% to close at $106.23 a barrel last week - reaching its lowest level in five months - as the U.S. dollar strengthened to its highest point against the European euro so far this year. Crude oil prices actually declined for six straight days - the longest stretch since they did so from April 30, 2007 to May 7, 2007.

U.S. fuel demand dropped 3.5% during the past four weeks. And unemployment spiked much more than economists had predicted. Even so, oil prices are still 41% higher than they were a year ago.

"Demand destruction and the strength of the dollar are tailor-made to send oil prices lower," Daniel Flynn, a broker with Alaron Trading Corp. in Chicago, told Bloomberg News. "If it weren’t for the active hurricane season, prices would be below $100."

Investors looking to hedge against the dollar’s decline earlier this year helped lead crude oil, gold, corn and gasoline to records. The situation reversed over the past month as the dollar rallied against the euro.

But the question now becomes: How will OPEC react?

The Organization of the Petroleum Exporting Countries, the cartel of 13 countries that supply 40% of the world’s oil, are scheduled to meet tomorrow (Tuesday) in Vienna. Iran and Venezuela - two of the perennial wild cards - have called for supply reductions because crude prices have plunged 28% from the record peak of $147.27 reached July 11.

"I think there’s a chance that next week could be very interesting because of the OPEC meeting,” said Christopher Edmonds, the managing principal of FIG Partners Energy Research & Capital Group in Atlanta, told Bloomberg. "It doesn’t look like OPEC will cut quotas, but they are likely to try to boost prices with rhetoric."

Typically, oil and gas prices decline after Labor Day as the return to school means families will be taking fewer vacations, while cooler temperatures translate into reduced energy demand.

The direction that oil prices take this time around, however, could be determined by Saudi Arabia, the world’s largest oil producer and the cartel’s key (most influential) player. Back in June and July, in an effort to blunt the soaring escalation in oil prices, Saudi Arabia opted to unilaterally boost its output by half a million barrels per day.

"Where Saudi Arabia is in this debate is crucially important - that’s our lynch-pin,” Jan Stuart, oil economist at UBS Securities LLC (UBS) in New York, said in a radio interview. Saudi King Abdullah "is on record [as] saying $100 [per barrel] is too high, but that was a little while ago. We don’t know what the Saudis are ready to defend and we do know the Saudis are the ones that would have to do most of the production cutting."

No matter what happens to oil prices in the near term, the long-term outlook is clear: Over the longer term, oil and gasoline prices are going to rise.

Let’s face it - they have to. We’re talking Econ 101 here. Anytime you increase the demand for a commodity - and don’t increase the supply - the price is going to head higher. And the oil that’s in the ground now around the world is all that there is.

Emerging economies such as China and India will stoke global demand for oil, monopolizing supplies and forcing global petroleum prices higher.

No matter what happens in the interim, the long-term script is set - so invest accordingly.

Looking ahead to the rest of this week, the economic calendar initially appears light. Friday brings two key reports:

• Analysts expect August retail sales data to confirm lackluster consumer activity, though some are hopeful that parents used the last of those tax rebates for some late school shopping.
• And the August Producer Price Index (PPI) also will be over-analyzed as investors determine how declining energy costs will impact the overall inflation picture.  The core data may not yet reflect lower oil and gas prices working their ways through other sectors of the economy.  (Bear in mind, many economists prefer to focus more on the core numbers, which exclude the volatile food-and-energy prices).

U.S. Federal Reserve policymakers are set to meet again on Sept. 16, so pundits will begin prognosticating in earnest, though most expect central bank policymakers to follow the lead of the European central bankers and stand pat on interest rates.

Original post

Comments

[bertil:]

OPEC can cut production since demand is down and with the higher Dollar get the same or more value for their production.

2008 Sep 08 03:07 PM

[Alex Filonov:]

'Over the longer term, oil and gasoline prices are going to rise'

Yes, if author means 30-50 years. If adjusted for inflation, no. Less than 30 years, nobody knows. Just remember, everybody was saying that house prices can't go down 3 years ago. And house prices never dropped in this country since Great Depression, that is, until 2007. Oil prices are much more volatile.

OPEC is a big unknown right now. Maybe they understand that it's in their best interest to let oil prices to the lever of $70-80. At higher level, so much supply coming in the next 5-10 years, they might get irrelevant.

2008 Sep 08 04:03 PM

[Reinko:]

Remember all those years when the Chicago school of economists with succes planted the next flag into the mind of OPEC:

When oil is not between 20 to 30 US$ a barrel, the world economy will get destroyed!

The OPEC bowed for years for wisdom like that, but they to have studied the way the world economy behaves when the Chicago folks are proven to be telling crap.

And beside delivering to the two Western oil markets, they could be delivering stuff at reasonable prices to other countries...

The low price deliverance to poor countries could be financed by maxing out some obese Americans or some stupid Europeans.

This all could be, yet if I would be OPEC I would not advice oil below 100 US$ because otherwise the Chicago folks would not understand where the wind is blowing from...

Good luck my dear OPEC!

2008 Sep 08 06:24 PM

[richpee:]

oil minsters ar emeeting now..rumor has it oil poegged at $100 cut back production to maintian it at thta price or above check your comments to
make sure your on target!

2008 Sep 08 09:09 PM

[Steven Hansen:]

oil price volatility is not in the best interests of producers or consumers or economies in general. look at the airline industry and other transport. what we need is a new mechanism for pricing which will stabilize the market.

2008 Sep 08 09:10 PM

[richpee:]

AP
Kuwait says no need for OPEC to cut production
Monday September 8, 5:21 pm ET
By Pablo Gorondi, Associated Press Writer
Kuwaiti minister says there's no need for OPEC to cut production

VIENNA, Austria (AP) -- Kuwait's oil minister said Monday that there is no need for OPEC to cut production, despite crude prices that have fallen nearly 30 percent since July.
Mohammed Abdullah Al-Aleem is part of an OPEC committee whose recommendations could play in OPEC's final decision on what to do about output.

He spoke on the eve of a meeting of oil ministers from the Organization of Oil Exporting Countries who will decide whether to reduce production or keep it at current levels.

"For the time being ... there is no need to cut production," Al-Aleem said, but he added that current supply had outpaced demand.

While officials from Iran and Libya who said there is too much crude on the market, the energy minister of the United Arab Emirates said OPEC's policy of keeping the world oil market "well supplied" had not changed.

Minister of Energy Mohammed Bin Dhaen al-Hamli was also quoted by UAE's state news agency as saying that crude oil stockpiles in heavily consuming countries are within recent average levels.

Oil prices have fallen nearly 30 percent from their highs above $147 a barrel.

OPEC President Chakib Khelil seemed to support, at least in principle, the stance that current oil supplies are enough to satisfy global demand.

"Definitely, there is plenty of oil on the market, " Khelil said upon arriving in Vienna, forecasting that by the end of 2008 or early 2009, daily oil output would exceed demand by between 500,000 and 1.5 million barrels.

Asked what OPEC's likely decision regarding output would be, Khelil said "all options are open."

As with most other OPEC officials, Khelil blamed speculators and a weak U.S. currency for the run-up in oil.

"What we are seeing now is that the inverse relation between the U.S. dollar and the oil price is verified," Khelil said.

Iran, the group's No. 2 producer, has been among the most vocal proponent of tightening the oil spigots.

"We believe the market is oversupplied," Iran's oil minister, Gholam Hossein Nozari, told reporters, adding that the ministers planned to make a decision on what to do about production after their review Tuesday.

Echoing those comments, Shokri Ghanem, the chairman of Libya's National Oil Corp., told The Associated Press: "There is a glut in the market that warrants creating order."

He said that OPEC members producing above assigned quotas should be urged to curb output in line with those limits.

"There is a lot of oil in the market, much more than demand," he said.

No one is predicting much of a cutback at Tuesday's meeting -- if any at all. Still, such a move would not even have been thought of with oil prices setting record after record back in July.

But the bull run appears to have paused, if not ended, which could provide some wiggle room at OPEC's Vienna headquarters.

Since crude surged to a record $147.27 a barrel on July 11, it has tumbled by over $40.

Light, sweet crude for October delivery rose a modest 11 cents Monday to settle at $106.34 a barrel on the New York Mercantile Exchange, as Hurricane Ike threatened oil and gas facilities in and around the Gulf of Mexico.

On Friday, however, the contract fell by $1.66 to settle at $106.23, a five-month low.

The downward spiral has led Iran to suggest that it is time to reduce output from the nearly 30.5 million barrels a day being pumped last month by the organization's members.

Still, a major cutback is unlikely without Saudi compliance, and the Saudis -- de-facto OPEC policy setters who are now producing nearly a third of total OPEC output -- have given no hint they favor that option. Saudi Oil Minister Ali Naimi has instead talked about a floor of $80.

OPEC has reason to be cautious.

Despite their precipitous fall, prices remain 14 percent higher this year than in 2007, and a barrel of benchmark crude still fetches four times what it did five years ago.

Any OPEC move Tuesday to pare back output would result in protests from the U.S. and other major consumers.

Despite their precipitous fall, prices remain 14 percent higher this year than in 2007, and a barrel of benchmark crude still fetches four times what it did five years ago.

Additionally, OPEC understands that high prices drive down demand and will likely try to find a balance between high profits and a price that the market can accept.

That middle way would mean agreeing to pare away at overproduction without reducing the overall output quota of 27.3 million barrels a day set in November for the 12 OPEC members under production limits.

Associated Press writer George Jahn contributed to this report from Vienna.

2008 Sep 08 09:15 PM

[green_cheeks:]

At this point, $100 a barrel is too expensive unless the dollar is deflated drastically. The rise to $147/barrel put the screws to our economy and that lasted for a short stint. Simply put, our economy can not afford to pay more than $80-$90 (today's dollar) a barrel for the long term. It has already been kicking our ass. We freaked out when it started to explode around $55. This has happened so fast to our economy that the catastrophic shock waves that were started two years ago are just starting to hit us in a relative sense in the housing market... and there are more to come.... for a while... It is just like a tsunami, the shores dry up and then all of a sudden a wall of financial terror will present it when we realize the reality of our position...
So for OPEC to put a floor on the market is not feasible for us nor them in the long run... the short run alone is economically suffocating.... Companies need to watch their bottoms lines like hawks... Therefore people are starting to lose jobs in increasing rates... What does the average person do when they lose their job and they don't have any savings? This is happening to people I know...

2008 Sep 08 10:53 PM

[NOWHEREMAN:]

Opec wants to maintain control, while a disaster of some sort will force oil up. A better solution to all these upstart alt. energy programs would be lower oil prices.

Just take a long look at the Carnage amongst the Alt. A. sector.

2008 Sep 09 09:26 AM