From Hero To Zero – The Rise & Fall of OPEC
Opec Office in Vienna, Austria
If we are to believe recent op-eds, OPEC is writhing through its final stages!
Mention is often made of how trading commodities is akin to gambling. However, nothing could be further from the truth. While we certainly can’t anticipate the net effect of all market forces at any one time, we can safely say that when the technical and fundamental indicators point in a certain direction, prices move accordingly. Nowhere has this been proven more than the commodities markets of late. The world is awash in cheap oil; so much cheap oil that it keeps on getting cheaper. Global over-supply continues unabated as the US, Canada, Russia, OPEC and other producers refuse to back away – not daring to give up market share. Black gold is oversold and the price is plummeting with every passing week. Brent Crude (Recently Fell Below $65) and WTI oil (Recently Fell Below $61) prices recently broke through their key support levels and they’re now heading into freefall with $55 eyed as the next foreseeable support level.
Why Should We Care What Happens With Oil Prices?
The oil price dropped to a 5-year low when it fell beneath $66 per barrel. Consider for a moment that the price per barrel was recently approaching $110. What we have witnessed in the space of barely a few months is a 50% reduction in the price of one of the world's most precious energy resources. From a consumer's point of view, cheaper oil prices mean lower prices at the pump. For consumers who travel a lot, airlines ticket prices will be coming down which will be a major boon to the industry as a whole. Extrapolating that further, bigger cost savings on travel and energy consumption translates into more personal disposable income. And this is precisely what we’re going to see in the run-up to the Christmas shopping period and beyond. Everyday folks will have more money in their wallets which retailers are hoping will find its way into their stores as 2014 prepares to close out. And this is precisely what is happening at this point in time, with major retailers across the US reporting stronger earnings on the back of plummeting energy stocks and oil prices.
According to Banc De Binary financial analysts, the net effect of a tumbling oil price is a massive stimulus for the global economy. Some figures go as high as $1 trillion, and this is substantial. But everything is so intricately interwoven that anything can trigger a reversal at any time. For example the US recently ended its quantitative easing policy and that’s likely to cause a tightening of liquidity around the world. The end of QE will be met with rising interest rates in the first half of 2015 which will further tighten the money supply in the US. With dangerously low inflation across the Eurozone, and a recession in Japan the global economic outlook is best described as cautiously optimistic.
But that is just one side of this complex picture. Plunging oil prices cannot continue unabated. Eventually consensus will have to be reached among key players, including OPEC, the US, Canada, and Russia about precisely how to tackle the extreme volatility in the commodities markets. Three years ago Time Magazine ran an op-ed posing the question: Is OPEC Dead? In the article, reference was made to the lack of cohesion within OPEC as regards increasing/decreasing oil supply, and OPEC's overall importance in the global oil markets. At that point in time, the price of oil was around $100 per barrel, and global markets were in the throes of one of the fiercest recessions ever seen. Back then, Saudi Arabia – the world's largest oil producer wanted to boost production to reduce oil prices (excess supply leads to a reduction in price), while Venezuela, Iran, Libya and several other OPEC members refused to comply. The price per gallon was $3.74. Russia also refused to play ball, and this is important as we fast forward to the present day. Russia is now trying to punish the US for the sanctions imposed upon it over its role in the Ukraine crisis. However the irony is that Russia will be shooting itself in the foot by continuing to oversupply oil. Europe is Russia's biggest consumer of natural gas. If the Russians flood the markets with cheap oil, the Europeans will no longer have any need to purchase Russian gas being sent in via the pipelines.
The global economy has recovered from the worst effects of the recession that rocked the markets from 2008 to 2013. However a series of geopolitical crises across the Middle East and Ukraine have reshaped the landscape in a way that now has various power blocs pitted against one another. Much of the economic jockeying for position is directed at the flourishing US oil shale market which is producing an estimated 10 million barrels per day and is now a major global producer. The acrimony between Russia and the US has the Russians dead-set against reducing their oil supply, since they wish to hurt US oil producers by maintaining these low prices.
"USA-SAUDI ARABIA" WILL PAY FOR THEIR "OIL PRICE MANIPULATIONS"!
It has been estimated that major US oil producers will start feeling the pinch once the price of WTI crude falls beneath $55 per barrel. At that point Bank of America warns that as much as 15% of US shale oil producers will be in the red. This is particularly true in the Permian basin, where oil production will have to cease as it becomes untenable to continue producing at these prices. This is where cheap oil begins to hurt consumers indirectly through the closure of shale oil producing facilities, the loss of jobs, plummeting prices of energy stocks and energy sectors across the board and a continued push towards alternative energy sources. The short to medium term outlook for the global economy is bearish with a high degree of volatility.
However there is an alternative opinion that is shared by Bank of America's nemesis – Citigroup. They posit that the budding US shale oil industry can sustain the current prices and even continue producing if the oil price drops to $40 per barrel. However, there is no doubt that various oil producing countries and trilling operations around the world are hurting, and staring down the gun barrel at this time. Countries that are particularly vulnerable to these historically low oil prices include Argentina, Mexico, Nigeria, Libya, Iran, Algeria and Venezuela. Countries like Saudi Arabia, Kuwait, Qatar and other oil-rich nations with significant buffers are not at risk of going into the red at this time.
Analysts do not expect the situation to continue indefinitely, since the excess capacity will eventually be used up and then prices will start rising as demand catches up to supply. Presently, there is an estimated 1 million barrels of excess capacity per day on the market. The inelasticity of short-term demand/supply means that regardless of how high or low the prices go, the market will continue to be saturated with an oversupply. However as prices fall, more producers will be forced out of the market and normalcy will return. The problems don't end there however, and the oil price slump will likely continue for several years when you consider that Australia will also be adding to the global oil supply.
The Future of OPEC is Bleak
For OPEC, the challenges are real. The US and Canada remain the bulls in an otherwise bearish market where prices are being dragged down. Since 2012, the production of crude oil has increased by 1 million barrels per day. Among OPEC members there is no consensus; Saudi Arabia remains determined not to relinquish an iota of market share. But the flip-side of the coin is that Saudi Arabia may be hoping to push down the price to bankrupt the US shale oil wells. For now, Iran has not been able to expand production (owing to ongoing sanctions) and to further depress the oil price. In terms of energy consumption, Asia is the number one importer and it will do everything in its power to maintain low prices to feed its insatiable appetite for oil. This is easily seen in countries like Venezuela, Iran, Iraq and Saudi Arabia. For example China imports an incredible 15% of its oil from Angola.
OPEC sends oil prices further down and you may be affected
OPECs leader – Saudi Arabia – has been unable to come to consensus with other OPEC countries to effect any policy changes. Yet another concern for OPEC – the global oil cartel – is that other players are more influential than OPEC. The US, Russia and Canada are by far the world’s biggest oil producers and OPEC has been relegated to minority status in terms of oil output. And the long-term outlook for OPEC is equally worrying: the world is moving away from oil, in search of alternative energy sources. For OPEC, it’s a catch-22. If it cuts supply, the prices will rise and the US, Russia and Canada will produce oil more profitably. By the same token, Asian countries will be adversely affected and they may switch allegiance to US and Canadian suppliers. If OPEC maintains supply, it will force many other OPEC member nations out of business and inundate the markets with cheap oil.