Despite Early OPEC Meeting, Some See Even Lower Oil Price Near Term

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.

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  1. césar españa

    don’t think we will see a barrel at 50$ no more…

    HSF have lost much money in their financial investments and the only way that opec countries and Russia have to recover their losses and attend their budgetary commitments is by increasing price trough the cut in production. They’ll do it for sure and I fear that we will see a barrel above $ 100 for the end of the year.

  2. eh

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

    Really? If OPEC thinks that due to a developing global recession demand for oil will fall, then I don’t think they’re alone in that. And if they decide to look out for their own interests by reducing output in order to try to prop up the price, then exactly why is that “scandalous”?

  3. EvilHenryPaulson

    I think we could see $50 oil in the near term for the same reason we almost saw $150.

    Once the margin to increase output is small enough, then speculators can move it from market-price to user-price, and similarly they can artificially increase that excess supply from market-price to producer-cost. The lower it is driven, the more rapid it will increase because it will clear out the marginal producers much faster. They might have the financing to lose $1 per barrel for a few months but they won’t wait around to see what happens if they lose $5 per barrel in a month.

    I don’t see OPEC fighting to uphold the price against the unwinding of a few months of futures. They already have their own contracts and think longer term because they have little control over the near term due to the supply chain.

    I don’t think OPEC will have as much of a problem meeting quotas as they have in the past. In the past 2 years when they announced they would increase output the truth was they could not bring new wells on line quick enough. With many key fields both inside and outside of OPEC now in accelerating decline, they simply have to calm output on the smaller/more-numerous newer wells and delay planned developments. They’ve also got the short-term benefit of Gulf of Mexico and Nigerian shutdowns

    The key factor will be how much money do the persian gulf states and Russia need for their budgets. If they choose to convert some of their USD and gold reserves at current high valuations, then the decision simply becomes how much production do they want to cut and not how much can they cut.

    It’s winter so the fuel-blends will reduce pricing power for now, in addition to seasonal reduced ship and airplane travel. We’ll have to wait to see their medium-term intentions come springtime. By then, several chapters will have been written economically.

  4. EvilHenryPaulson

    How many trillions of dollars of wealth have been lost in the oil crash?

    October 20, 2008 8:30 AM
    From memory:
    Around 86mn barrels per day globally
    = 31.4tn annually globally

    Assume all were valued at a market price of $147.27 and then suddenly worth $50, => $3.05tn

    JPM has been king of commodities since it took over Bear Sterns, but GS and MS had been large players and I think JPM might have turned the tide on them to force them to liquidate their futures while they could. It will be interesting to watch the open interest between contracts available say before September and after December

  5. Anonymous

    Evil Henry,

    3trn annually is right. What about in terms of reserves though? Since we like to bandy about evaporating wealth rates.
    World proven = 1.25trn barrels. Evaporated wealth = 119trn USD.


  6. EvilHenryPaulson

    anonymous @10:08am,

    Oil reserves is a ethereal number. The proper definition is the amount of oil that can economically be recovered.

    Thus if price drops, then so do reserves. Often government bureaucrats confuse reserves with oil in place.

    I do not understand your maniacal laughter because first of all they have not sold their entire reserves for $50 per barrel. Second of all oil is a very remarkable substance that we cannot duplicate for a cost well above the existing price which includes a driller’s profit.

    It will only gain value if they leave it in the ground for a few more years — unlike real estate many users of oil generate substantial profits for each barrel of it they use and those margins are available for price increases so long as excess supply of oil is tightened. Even trying their hardest, oil demand growth will easily outstrip oil supply growth ignoring the credit crunch because we still have to see what kind of economy we have remaining

  7. Anonymous

    Yes Evil Yes!


    Its actually even more complex than that!

    …. “they have not sold their entire reserves for $50″… Does not the same apply to real estate, debt, equities?

  8. SlimCarlos

    EHP >> Second of all oil is a very remarkable substance that we cannot duplicate for a cost well above the existing price which includes a driller's profit.

    Exactly. Was $140/bbl a bubble then? Some folks think by definition something that goes up in price quickly is a bubble. I would suggest that a bubble is characterized by a flood of supply, be they tulips or dotcom IPOs.

    We did not see massive stock building in oil. We did not see a surge in production.

    At any rate, now the specs got a hard on to drive the price down. This will lay waste to future production capacity.

    And I will venture that there won't be a single congressional hearing to find out why.

  9. DownSouth

    In the immediate time frame, it appears that OPEC, and more specifically Saudia Arabia, holds all the cards.

    If Saudia Arabia’s royal family decides the price of oil will go up, then it will go up. If it decides the price of oil will go down, then it will go down.

    It all boils down to a guessing game as to what the Saudi royal family will do.

    If one can divine what is in the best interests of the Saudi royal family, or what the Saudi royal family thinks is in its best interests, then one can divine the price of oil. But remember, the Saudi royal family has at its fingertips an order of magnitude more information–geopolitical, economic and geological–than what you and I, or any one of the analysts quoted above, could ever hope to have.

  10. joe c

    From 1979-83, according to IEA, global oil consumption dropped 11%. If economy slows same today, that would mean 8 million extra barrels. We could easily see $20 a barrel, OPEC has never hung together going down.

    That said as soon as growth picks up, oil will go up rather rapidly. We do have an energy problem.

  11. EvilHenryPaulson

    joe c,

    Look at Japan’s GDP per barrel of oil consumed over the last 30 years. There are now alternatives for lowest cost producer of goods against the headwind of expensive oil.

    It took a rare confluence to bring addition of new wells and supply against a decline in air travel with still injured shipping due to the Asian financial crisis.

    The wells that have been brought on line this time merely keep production at 2003-2005 levels. Be honest, your $20 per barrel argument is more of a self-serving argument than a real proposition

    Finally, OPEC matters less in today’s world than it did in 1970 in the sense their portion of global supply has declined. Yet with a dearth of supply to offset declines of fields first tapped in the 1970s, they retain enough power to control the marginal excess supply — so they’re not irrelevant either.

  12. mxq

    Like they say in the matrix, “theres a difference between knowing the path and walking the path.”

    As Yves alluded, Venez. and Iran pretend to define OPEC’s fate when, in fact, SA is in complete control of that fate.

    Venezuela is struggling just to meet its own quota, yet they need $90 oil; so while they are the most voiciferous in calling for a cut, they’re actually the last ones that are going to significantly cut their production. A downward price spiral plus a production cut is a double whammy to revenue…of course cut production is supposed to reverese that price spiral, but then again, nobody wants to be the first.

    Via platts: “Most member countries will readily agree to output cuts that they will not have to implement, but it will be Saudi Arabia’s response that will really matter,” it said. “With the OPEC basket price around $70/b, the Kingdom did not appear to see the need for a steep cut in its production…”

  13. William Mitchell

    Oil shocks no longer come as a complete surprise to industrial countries, so we now adapt faster.

    Vehicle miles in the US started dropping almost immediately after the big oil spike. SUVs have vanished from the roads in my southern Calif neighborhood.

    Add to this a consumer recession and the collapse of leveraged speculation, and $50 starts to look believable.

  14. Anonymous

    I doubt the Saudis wrote the book on their reserves more like a Texan or Englishman did and the overview didn’t support peak oil.

    In the meantime, oil companies didn’t fancy to chasing windmills so today’s oil prices hinder alternatives before they even get traction but who has the cash lately to stockpile oil even at these prices?

    Probably have to watch the reserve currency as a commodities to paper value controls price.

  15. Anonymous

    Also, saber rattling by the likes of Iran, Russian and their wannabe upstarts will be punished.

  16. joe c

    evil henry paulson

    “Be honest, your $20 per barrel argument is more of a self-serving argument than a real proposition”

    Dont have any play in oil. Everyone is in la-la land that thinks the present global economy is not entirely dependent on oil. Last quarter of 2007, Dow hits record high, oil hits $80 a barrel, and GDP contracts -0.2. That’s the magic number, the presently structured American economy cannot run above $80 a barrel, we should set it as a floor, actually it would be better higher.

    If the economy slows to the extent it did in early 80s, oil will drop to $20 — count on it.

  17. mxq

    Via CNBC from Last Friday:”Venezuela’s state run oil company, PDVSA, is urgently searching for replacement financing after losing a line of credit of more than $5 billion from the Royal Bank of Scotland, CNBC has learned”

    However, RBS issued this last Saturday:
    “RBS says no credit pulled from Venezuela’s PDVSA”

    This is almost boarderline tinfoil hat stuff, but assuming cnbc was right, maybe OPEC (specifically Saudi Arabit) WANT lower oil prices to come about, that way weaker players like Venezuela and Iran have to cut their own production b/c of a lack of credit?? That would be win-win for SA – supply and demand would go to optimal levels, yet Saudi production would continue (maybe even increase?).

    Total speculation, though.

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