Will OPEC production cuts work?

Chap08_in_barrel_of_oil "Even the Saudis, who argued for keeping the markets well supplied at the last OPEC meeting, seemed to have been struck by the speed of the price drop.

When prices spiked this summer, the cartel’s leaders attributed the jump to speculation, and Saudi Arabia, the world’s biggest oil producer and OPEC’s most powerful member, opened the taps and increased production to a record of 10 million barrels a day. The Saudis have since pared their output to around 9.5 million barrels a day, according to analysts.

As the lowest-cost producer, Saudi Arabia can afford to let prices fall for a while without hurting its budget. Most analysts estimate that the Saudis could live with oil at $55 to $65 a barrel. But other producers need higher prices. Nigeria’s oil minister said his country would be more comfortable with $80, Qatar has set a range of $70 to $90, and Iran’s representative said that prices below $90 a barrel would hurt.

For Iran and Venezuela, the drop in prices is particularly painful,"  NY Times


OPEC agreements on production cuts are not going to halt the fall in the world price of crude.  The fantastic prices that prevailed in the Summer of 2008 were the outcome of trading in oil as financial investments rather than as commodities.  Deregulation led to this as it led to speculative excess in many other commodities (real estate derivatives being the most famous example).  A valuation of crude by the financial markets resulted that had little to do with short term demand and everything to do with the boundless "greed" espoused by Gordon Gecko.

The collapse of the stock and credit markets that has occurred has started an unwinding of the fantasy of the false short term valuation of crude oil.  At the same time the actual economic slowdowns that are happening around the world are reducing real short term demand for oil to even lower levels.  This produces a downward spiral that has a certain built in momentum.

The oil producing countries need the revenues that they were earning at the inflated prices of oil that prevailed last Summer.  In many countries the governments themselves are the principal owners of the oil producing companies.  A loss of revenue by the oil companies is a direct "hit" on the governments’ budgets.  Political stability in these countries is to some extent dependent on budgets.  Cutting production is a gamble that many of these governments will hesitate to adopt.  Cheating on OPEC established quotas for production is an old feature of the oil supply situation.  In addition, there will be countries who will simply not "play ball" with OPEC in this.

Conclusion:  Production reduction efforts on the part of OPEC will not be fully effective.  Demand will continue to fall for some unforeseeable period of time. Therefore, crude oil prices wil continue to decline.  To what level will prices decline and for how long?  That is not knowable at this time, but It is likely that price will decline to below 50 dollars a barrel.  pl


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20 Responses to Will OPEC production cuts work?

  1. Bill W, NH, USA says:

    Well, I can only hope. We decided not to lock in on heating oil price last Summer and it’s paid off big-time. Neighbor is paying #4.28 per gallon and we can buy it now for $2.99 but are holding off (still have 130 gallons in the tank) for, hopefully, further price decreases.

  2. charlottemom says:

    In support of your theory on the falling oil prices, Duke Power is scaling back its proposed $ investment in alternative power – solar technology – by 50%. My two takeaways: 1) oil prices will continue to fall; 2) cash is king.
    Additionally, wind/turbine technology is hitting a wall with investors.

  3. John Hammer says:

    For Iran and Venezuela, the drop in prices is particularly painful,” NY Times
    The Saudis have some interest in sending a newly ascendant Iran back to the hurt locker.

  4. DanaJone says:

    So whats to stop other OPEC producers from cutting back production if price drops below a level they like? The SA’s can make up some of the missing production, but not all. If other producers hold back to keep oil above $50-60/bbl, how long could they do it? Iran is very dependent on oil exports, even tho they are being limited by sanctions. What about Russia? They have said that they are going to start stockpiling oil, which means less going to market.
    Even our own oil companies don’t want to see it below $50, it will cut into their record profits that they have gotten used too.

  5. Dave of Maryland says:

    Good as far as you go, but you forgot the value of the dollar itself.
    Last summer, a Euro would buy $1.50-something USD. A Pound would buy $2.05 dollar. The Canadian & Australian dollars were both roughly equal to 1USD.
    As of right now, a Euro buys only $1.27USD. A Pound will only get $1.59USD. The Canadian dollar is down to .78, the Australian dollar is at .62 (Source: XE.com)
    America might have cheap oil, cheap commodities in general, but the rest of the world does not. Presumably this is because panicked investors are buying Treasuries, thus bidding up the cost of dollars. Whatever it is, it’s wrecking the US export market. Which was about the only bright spot around.

  6. ernest cooney says:

    The cutback by the oil cartel will only work if we go back to our old habits of wasting energy,we have to continue to cut back and go foward with programs to reduce our dependance on terrorist oil that our troops die for and obliges us to keep a strong force to protect dictators thathold us hostage to purchase their oil, stand strong and together america until we eleminate the imports from these terrorist nations that kill out sons and daughters.

  7. Curious says:

    OPEC cut production twice during the Bush adminsitration:
    1. during mid term (a small spike) and 2. run up to Iran war/november election.
    They hold their line both. They also increase production after $146 peak, after global economy experiencing crunch.
    So, they can hold their line. (Not even Cheney two visit to saudi can fix the price)
    OPEC country challenge now is to maintain balance between preventing Asia to enter recession, Europe from collapsing, and US in light of incoming Obama administration.
    (This is in absence of renewed Israel-Iran spat. by now Iran is very much capable of shutting down the planet oil supply)
    It seems there isn’t much to control in oil supply side.
    in term of Domestic economy. GE is about to join “zombie brigade”. This company has a half a billion debt.

  8. Cynic that I am still discounting price changes pre-election. Also why no stories of hedge funds and traders getting burned by price decline of oil? Well maybe they all shorted after finding a price point that could not be realistically supported. Some people made big bucks on this rapid drop. Who?

  9. zanzibar says:

    Great call Pat on timing the crude bubble top!
    The economic consequences of the deleveraging is just coming to the fore. Russia’s $500 billion reserves could get used up real fast if private capital flees a possible sovereign default. What happens to Dubai’s construction bubble? And how long will Chavez strut around?
    Hank Paulson claimed that unless he got carte blanche to save his Wall Street co-conspirator’s personal wealth we would face financial armageddon. Since Congress happily gave him a blank check using middle class American’s personal account we have seen equity and credit markets collapse around the world. The unintended consequences of Wall Street Crony Welfare continue to build. All the policy actions so far mimic what Japan did after its credit and real estate bubble – the only difference being that Japan had a large savings pool. Result: Japan has had a 20 year bear market with subpar economic growth despite ZIRP, government guarantees of bank credit, accounting forbearance and enormous fiscal stimuli as well as growth in their central bank balance sheet to 30% of GDP. Japan’s government debt grew from less than 100% of GDP in 1996 to over 180% of GDP by 2006.
    The price that we could pay for “rescuing” the bad private investments of Wall Street could be the destruction of the pristine credit worthiness of the US Treasury and the loss of the USD as the reserve currency.(hattip:naked capitalism)
    Trading short term pain for long term disaster is never good national strategy in my opinon.

  10. Charles Cameron (hipbone) says:

    FWIW The National (UAE) gives rather different figures:
    The International Monetary Fund was expected yesterday to publish a new regional economic forecast estimating that Iran needs average oil prices above $90 a barrel to avoid a budget deficit and to remain above $75 a barrel to cover its import bill.
    Deutsche Bank also recently estimated that Iran and its fellow anti-US ally, Venezuela, need an oil price of more than $95 a barrel to break even compared with $55 for Saudi Arabia. The IMF said the Saudi budget remains in balance unless oil falls below $50 a barrel; its “break-even” figure for the UAE is a mere $23 a barrel and $33 for Kuwait.
    Iran in troubled waters as oil plunges¸October 20. 2008

  11. Morochos.net says:

    I do not believe that the cut has major effect in the oil market, but it is necessary, considering the present conditions. I make a greater explanation in my blog.

  12. R Whitman says:

    Both Venezuela and Iran are grossly mismanaged financially. They will have problems whether the price of oil is $50 bbl or $150 bbl.Mexico can probably be included in this category also.
    Lets not try to predict the price of oil. All it takes is one bomb in an inappropriate place to scare the hell out of the oil commodity market. I have been involved in the oil industry for 52 years and have seen 6 drastic, abrupt, unanticipated shifts in price during that time.

  13. JohnH says:

    “For Iran and Venezuela, the drop in prices is particularly painful.” Alaska, too. These are among the few places where oil wealth is broadly distributed among the population. In other places, like Nigeria, the elites will have to cut back on gold plated Mercedes.
    I look for prices to fall for a couple years, but begin to rise rapidly at the suggestion of an economic recovery. Rapid depletion of existing fields continues apace, but investment in new production will be put on hold, since credit is tight and much of of the new potential will not be feasible at lower prices.
    Unless there are some dramatic new, low cost discoveries, we have simply kicked the problem of high cost oil down the road a couple years.

  14. Ed Webb says:

    I concur. Another part of the world where lower prices will hit hard is the Caspian basin. The established Kazakh fields will keep pumping, but exploration and extraction is very expensive in that region, and when crude drops to 50 or lower and stays there, and it becomes apparent that recent prices have been a bubble, it will be harder to attract investors to sink the costs of exploration into those chilly waters.

  15. Roman says:

    I do not think that the cuts in the production will work. After almost a year of traveling by mass transit. We are used to it. Plus, the amount of people who switched cars from SUVS to higher mileage cars HUGE to say the least. The gas intake of the us will keep on falling. No matter what OPEC will do

  16. Kurt Van Vlandren says:

    Your phrase “the oil producing countries need the revenue ….” is the key to our withdrawal from the region. The occupied countries detest us because they are occupied. Our rationale for being there is: we need the oil.
    They will sell it to us even after we’ve come home. They need the money and we need the oil. Removal of our military presence won’t change that no matter what the regime

  17. Curious says:

    Both Venezuela and Iran are grossly mismanaged financially. They will have problems whether the price of oil is $50 bbl or $150 bbl.Mexico can probably be included in this category also.
    Posted by: R Whitman | 25 October 2008 at 06:04 PM
    Venezuela may have slight trouble balancing budget. But considering they are running totalitarian gov, I doubt they will have difficulty tuning economy in the blink of an eye.
    Iran? If I have to bet my money between their economy or our economy, which will crash first in the nest 12 months, I will put my shiny dime on theirs. (1. Their exchange reserve is in Yen/Euro. 2. Their economy is relatively insulated from global trade.) With the gathering currency crisis storm, they are some of the biggest economy that will survive, by virtue of being isolated for so long.
    The financial market crisis is now hitting the global currency market. (Iceland, entire eastern europe. Korea, part of Asia. Argentina.)
    How all this will affect dollar stability is the question. (Remember US economy is crashing hard right now. very hard, but only the beginning, so the clown in DC still think it’s all OK.)
    In the last few weeks, the currency market is where the action has been….all of this is a prelude to some sort of currency crisis….
    But, it is in commodity and emerging market currencies where the trouble is brewing. First, we saw a nightmarish plunge of the Australian and Kiwi Dollar as commodities plummeted. This all out assault on commodity and emerging market currencies then widened to include the Icelandic Krona, the South African Rand, the Polish Zloty, the South Korean Won, the Hungarian Forint, and the Mexican Peso amongst others.
    This speaks to hot money fleeing emerging markets wholesale…. today, I caught two interesting perspectives on this debacle that made me blanch.

  18. Curious says:

    BTW, you want to know where all these “bail out” free cash is going?
    Well… unlike previously during Bear stern when it was being used to speculate commodity. (which causes food riot across the globe and ultimately global market slowing down)
    Now the cash is being used to speculate currency. Trillions of them. (remember Soro brought down the British pound using only some $50Billion bet against it.)
    Forget oil price. It will feel good for a few months, then we will see the effect of global trade crashing because the currency fluctuate so much, no country can do trade. (By spring we will know what become of US dollar. Pray hard Saudi doesn’t unpeg Real.)
    Welcome to free market.

  19. Kevin says:

    “For Iran and Venezuela, the drop in prices is particularly painful”
    Great opportunity to foment arab insurrection inside oil rich khuzestan 😉

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