Mark Sept. 9 down on your calendar for what could be one of the pivotal dates of the early 21st Century.
Or not.
That’s the date of the next OPEC ministerial meeting in Vienna. Often these gatherings are pro forma affairs that merely validate for public consumption what has already been decided behind closed doors in the weeks heading up to the meeting. This one, however, is a bit tougher to read than usual.
We can expect the usual price hawkishness from Venezuela and Iran, which apart from both having certifiable nutjobs as presidents, also share the dilemma of watching their oil production decline despite a massive oil resource base. Given their current course, it might not be too long before both countries join Indonesia in the ex-OPEC club of net oil importers.
There will be rhetorical jockeying for position from other OPEC members, mostly arguments for staying the course on production despite slumping demand spurred by record high oil prices.
In the end, what counts is how Saudi Arabia will react to that decline in demand. That the kingdom holds nearly all of the world’s thin cushion of spare productive capacity gives it the whip hand. So far the Saudis are keeping mum—acting even more reticent than usual, and the Saudis are hardly verbose. But there has to be some concern in Riyadh about the fall in oil demand.
From a record peak approaching $150/bbl earlier this summer, oil had lost about 24% of its value until Russian tanks rolled into Georgia and Tropical Storm—perhaps soon to be Hurricane—Gustav rolled across the Caribbean. Oil prices remain below $120/bbl at this writing even with one of those events still unfolding.
Weakening demand is raising the specter of a repeat of the oil price collapse of 1998. That year OPEC had ignored the slump in demand caused by Asian economic woes and promptly jacked up production, leading to the plunge in oil prices. Ever since then OPEC has carefully calibrated production to sustain an ever-higher price floor. But the organization may have overreached, finally reaching a point where demand has withered in the heat of blistering oil prices.
US oil consumption in the first half of this year posted its biggest 6-month drop in 26 years. Remember 1982? That’s when OPEC, faced with slumping prices due to declining demand, started the practice of meeting regularly to negotiate members’ production quotas. Said quotas were roundly violated, leaving Saudi Arabia to act as swing producer to support prices until its own market evaporated, which spurred it to flood the market and thus collapse oil prices completely.
Could another price collapse be in the cards because of OPEC overreaching on price? Forecasts are calling for modest growth in global oil consumption this year and next. As demand has fallen significantly in the developed nations, that decline has been offset by strong demand growth in the developing world—especially China, India, and the Middle East. But moves to reduce subsidies for fuels are already reining growth in the latter.
Saudi Arabia has already expressed some concern about sky-high oil prices causing demand destruction and ultimately eroding markets. The Saudis back in July weren’t too keen on oil prices surpassing $100/bbl, much less approaching $150/bbl. And they put their money where their mouth is, boosting production to 9.7 million b/d vs. their quota of 8.9 million b/d.
It’s unlikely the Saudis would increase production again in order to further dampen oil prices. That would come out of that sliver of existing spare capacity, which could have the unintended consequence of causing an even worse oil price spike in the event of a major supply disruption somewhere in the world. And it wouldn’t sit too well with some others in OPEC who really are quite fine, thank you, with oil prices well over $100/bbl.
But is a Saudi-led cut in oil production to bolster prices conceivable?
Oil markets may be reaching a critical inflection point. Economies are suffering, demand is falling, and the calls for new energy pathways away from oil altogether are getting louder by the day. The latter element poses the biggest threat to oil’s future because of its potential for permanence: the anti-oil crowd now gets to trumpet its trifecta of woes: climate change, wars over oil, and the peaking of oil production. We are probably a couple of price spikes to $200/bbl away from An End to the Oil Era in Our Lifetime.
Would the Saudis feed that trend by taking action on production that would cause the price of oil to spike yet again? It would seem inconceivable, but remember this: All the screeching against oil and OPEC can have its own unintended consequence.
Put yourself in an OPEC member’s shoes: You are selling a commodity that is used universally, one that your customers can’t live without and keep using more and more every year. But their consumption has been so rapacious that it’s hard to keep up the supply, so the price naturally rises as the prospect of supply shortages grows. Your customers then start telling you every day essentially that you’re evil scum for selling the stuff to them and that they’re going eventually stop buying it, and the sooner the better.
What would the last guy selling buggy whips have done had he known what Henry Ford was cooking up, especially if he didn’t have anything else to sell? Wouldn’t he cash in as quickly as possible? Isn’t that human nature—to amass as much wealth as we can while we are able so that we can survive comfortably on our nest eggs when we are no longer able to amass that wealth?
If you know the market for pretty much the only thing of value you have to sell is going to go away soon—and for good—what would you do? Would you start to entertain the notion of getting as much money as you can for that commodity before that fateful day occurred?
If the Saudis were to lead a production cut at the Sept. 9 OPEC meeting, it would almost certainly be the tipping point for the future of oil markets. An outraged oil consuming world would then be set irrevocably on an accelerated path away from oil, believing that even the wrenching economic dislocation that would result from the forced introduction of alternatives couldn’t be any worse than a future of $150-plus oil. Just as in the early 1980s, OPEC would be sowing the seeds of its own destruction.
That probably won’t happen. The Saudis have always been the voice of moderation in OPEC. No one is more keenly aware of defending market share than Saudi Arabia. So Sept. 9 will probably pass with OPEC taking no substantive action to increase or decrease production. The Saudis will probably take some quiet pleasure in watching the largesse of Venezuela and Iran, propping up those dangerous regimes, dwindle as slumping demand continues to trim prices. The kingdom probably won’t really sweat if oil prices slide below $100/bbl, perhaps taking action only when a floor of $75/bbl was threatened.
But what if Saudi rulers had the (pardon the expression) mentality of a Hugo Chavez? Or of Mahmoud Ahmadinejad? What if Saudi Arabia were really looking a precipitous, “peak-oil” decline of its own production?
Sometimes I wonder if the Saudis just get tired of all the invective and demonizing of them and their oil and indulge in a little “be careful what you wish for” fantasy.
What if you had the last buggy whips in the world, nothing else to sell, and everyone still had a horse and carriage—but they all told you they would trade them in for Model T’s in a year?
Yeah, me too.
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Chris Moran
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Thanks for the kind words, Chris.
Be sure to check back every week.
Regards,
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