naked capitalism

What a difference six months makes. When we questioned the thesis that the oil price runup earlier in the year was due solely to supply and demand, we got a fair number of hostile comments (see here and here for some of many examples). And now the view that oil will keep falling has also developed a life of its own. Options contract prices indicate that a significant minority of traders are betting on $50 a barrel oil by December.

Even though OPEC moved its scheduled meeting up nearly a month, signaling eagerness to take action to combat plummeting oil prices, some traders remain convinced that oil prices have further to fall. Given that some expect OPEC production cuts of one to two million barrels a day, when demand for oil fell peak to trough by roughly eight times that much in the 1970s oil crisis, it is quite possible that OPEC’s move may be inadequate in the light of declining consumption.

A perennial problem is diverging interests among OPEC members. iran and Venezuela need high oil prices to make their sulfurous, heavy crude economically viable and are calling for cuts deep enough to keep oil prices above $80 a barrel; Saudi Arabia, which has far and away the most clout by virtue of the size of its reserves, also has far and away the lowest production costs and thus is less affected than other producers by price declines.

From Bloomberg:

OPEC, the supplier of more than 40 percent of the world’s oil, plans to cut output for the first time in almost two years as the worst financial crisis since the 1930s sends crude toward $50 a barrel.

Options contracts to sell oil at $50 by December soared 28- fold in the past two weeks on the New York Mercantile Exchange. Goldman Sachs Group Inc. and Merrill Lynch & Co. analysts say crude, which fell more than 50 percent from a record high in July to a 14-month low last week, may drop another 44 percent should the world economy slip into a recession.

The Organization of Petroleum Exporting Countries, which meets Oct. 24 in Vienna, three weeks earlier than planned, is facing the weakest growth in demand since 1993 just as new fields come on line from Angola to the Gulf of Mexico. Members may cut daily output by as much as 2 million barrels, President Chakib Khelil said yesterday.

“OPEC is going to try to prevent some of the price decline,” Francisco Blanch, head of global commodities research at Merrill in London, said in a Bloomberg television interview. “It’s going to be very difficult to stem a price fall.”

Options contracts that allow holders to sell 1,000 barrels of oil for $50 each by December closed at $280 on the Nymex on Oct. 17, up from $10 on Oct. 3. Oil rose a second day today, gaining 0.8 percent to $72.45 a barrel at 7:50 a.m. in Singapore…

Attempts to support prices when the Standard & Poor’s 500- Index is down 36 percent this year may sour relations between OPEC and its customers. Both U.S. presidential candidates, John McCain and Barack Obama, have called for greater energy independence to limit reliance on foreign oil.

U.K. Prime Minister Gordon Brown described potential supply cuts as “absolutely scandalous” on Oct. 17, Agence France- Presse reported.

The world’s industrialized economies will expand next year at the slowest pace since 1982, the International Monetary Fund said Oct. 8….

While OPEC already agreed to curb production by observing output quotas after a Sept. 10 meeting to lower supplies by 500,000 barrels a day, members routinely pump more than their allocation, according to data compiled by Bloomberg. Since that session, Credit Suisse Group pared its forecast for oil next year by 32 percent to $75 a barrel. Deutsche Bank AG cut its 2009 assessment by 23 percent to $92.50 on Sept. 29. BNP Paribas SA lowered its outlook by 18 percent to $92.50 on Oct. 10.

At the same time, Exxon Mobil Corp.’s Saxi-Batuque fields off Angola’s shore started pumping in August, while BP Plc’s Thunder Horse field in the Gulf of Mexico is scheduled to increase supplies by the end of the year. World oil capacity will rise 1.45 million barrels a day in 2009, twice the rate of growth in demand, according to the International Energy Agency.

“Prices could fall as low as $50 a barrel during the fourth quarter if OPEC can’t find a way to offset the financial meltdown,” said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts…

As demand declined, OPEC trimmed supplies 3.8 percent to 31.8 million barrels a day in September, according to Geneva- based tanker-tracking service PetroLogistics Ltd. Saudi Arabia’s volume fell 520,000 barrels a day to 9.18 million, PetroLogistics said.

“This may be OPEC’s toughest balancing act in their history,” said Tetsu Emori, the fund manager at Astmax Co. in Tokyo, Japan’s biggest commodities asset manager with $200 million under management. “By the time OPEC announces a cut, they would be hoping to have seen the bottom of the price.”…

“The situation has gotten dire enough that they’re willing to move and even become a topic of conversation” during the U.S. election campaign, Ronald Smith, chief strategist at Alfa Bank in Moscow, said in a Bloomberg television interview. OPEC will cut by 1 million barrels a day “at the very minimum” and potentially “wait until after the election, then add another million on top of it, or half a million,” he said.

Further commentary from AP:

A crude oil production cut of even 1 million barrels per day at OPEC’s upcoming emergency meeting is unlikely to reverse slumping prices in the short term, analysts said …

Over a three day period last week, the November-delivery contract on the Nymex dropped $11 per barrel, rebounding slightly on Friday only on the back of OPEC’s announcement of the emergency meeting.

But even that gain could be short lived, say some analysts, as the market factors in the anticipated cut ahead of the meeting.

“In the very short-term … OPEC will likely prove unable to significantly alter the prevailing market sentiment, particularly as crude traders look to equities as a barometer of global economic health (and hence oil demand),” said a recent PFC Energy report.