Blue Point Trading - No OPEC cut, Oil Tanks, What Next?


No OPEC cut, Oil Tanks, What Next? Saudi Arabia blocked calls last week from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to a fresh four-year low.

Watching the market volume on a holiday non-pit trading day, clearly a lot of forced liquidation of hedge funds. I was a little surprised at the sharpness of the move, as the OPEC meeting outcome was well communicated in advance. In any case what’s going on here and where do we go from here? There are several ideas floating around, so let’s examine them and analyse them a bit.

The first idea, a nefarious conspiracy theory, is that a US, Israeli and Saudi alliance engineered this to kill off their geopolitical enemies; Russia, Iran and Venezuela. Perhaps a factor, but this implies these folks can think strategically together on a long term basis. Judging how the Obama foreign policy is in such shambles, assuming this kind of intelligence can get you in trouble.

Another idea is that the Saudis are trying to kill off the recent Oil boom in the US. Oil production costs are high in the US, and for sure lower prices will have an effect. But many of these investments have been in the pipeline for a while now and will not be stopped on a single trading day, though perhaps new projects could be put on hold. Besides the US Oil/Oil shale boom is a little over hyped. Sure US production has risen (nearly 4m bbl) over the past 5 years, but why all of sudden the price plunge now? The US production difference from just a year ago would not justify this sell off.

Along this same idea as the previous, some have suggested that OPEC wants to kill the alternative energy industry, which is growing exponentially in recent years. Perhaps a background issue, but at best OPEC can merely slow this down a bit and still does not explain the sudden sell off.

The wealthy Gulf states have made clear they are ready to ride out the weak prices that have hurt the likes of Venezuela and Iran – OPEC members which face big budget pressures, but cannot afford to make cuts themselves. Venezuela and Algeria had called for output cuts of as much as 2 million bpd. So the Saudis have to walk a thin line between these two camps, though they hold all the cards.

Igor Sechin, chief executive of state-controlled oil giant Rosneft, traveled to Vienna ahead of OPEC’s Nov. 27 meeting, prompting speculation that Russia, which isn’t an OPEC member, might agree to curb production in tandem with the cartel. They simply can not for budgetary and technical reasons. Other non-OPEC countries are in the same predicament. Besides, these hurting Oil producer’s currencies are tanking as well, hence the lower Dollar price of Oil does not hurt their locally denominated commitments. Their people will just have to suffer the inflation effects. Hence an OPEC cut of their current 30m bpd from the total world production of 94m bpd, would be merely cutting their own throats. So it is a price war.

Global supply and demand are largely in balance, though supply is about 1.5m bpd too heavy – click here. With Oil producers running at full capacity and global growth slowing, the markets are forcing producers to cut back. OPEC seems to be banking on better demand and do not want to loose control of their shrinking market share. They have bought into this central bank thinking that global growth is just around the corner. Faulty thinking?

My take is that the new trading range for Oil is $60 to $75. To break out of this range will largely depend on demand, as these new lower prices will hold the supply in check, while existing production resources continue to pump at full steam. If the global economy expands we could get a return to higher prices, if not they could tank further. For other economic reasons the latter could be in the future – economic stagflation and deflation are the macro themes today. Oil prices are just coming to understand this reality. Other markets will soon understand this as well (i.e. US stocks).

All this is always dependent on geopolitical events. One fear I do have, is that countries like Iran and Russia are hurting. They have now a greater incentive to cause an incident, that would boost Oil prices once again. Of course this would be a disaster for global growth, that is already faltering. Sorta feels like a perfect storm is brewing – yipes!

Blue Point Trading, William Thompson