Is the OPEC cut a good thing?
Posted
Dec 17 2008, 12:57 PM
by
Anthony Mirhaydari
Rating:
Everyone's favorite cartel is at it again: OPEC's oil ministers just agreed to a production cut of 2.2 million barrels a day in Oran, Algeria as they desperately try to halt an epic slide in crude prices. This is the single largest supply cut since 1982. A total of 4.2 million barrels of production have been cut since August.
The Saudis believe that moving oil over the $75 a barrel hurdle is "for a much more noble cause" that will -- as I discussed in a previous post -- avoid the cancellation of new exploration and production projects so prices don't spike when the global economy recovers. The head of the International Energy Agency is of the same mindset, noting that "current prices are too low."
Could the oil ministers be doing us all a favor?
Now the question is whether OPEC can make deep, disciplined cuts faster than the global economy spirals downward. Earlier this month, the U.S. Department of Energy released a report projecting global oil demand to fall this year and next, which would be the first back-to-back decline in 30 years.
Complicating matters is a classic prisoners' dilemma situation where each of the cartel members has an incentive to cheat, pumping more oil than it should, while others play by the rules, cut production, and drive the price higher. With oil prices trading lower at the moment, it's a sign that the market believes OPEC members like Iran and Venezuela, which depend on oil revenue to fund populist government policies, are unlikely to honor the cut.
Of course, there is also the issue of the 50 million barrel supply overhang stored in supertankers anchored in the Persian Gulf, the Gulf of Mexico, and the North Sea. This has been caused by the steep "contango" in the oil futures market, where producers earn much more by storing crude today to deliver in the future.
For now the eyes of oil traders and SUV owners turn to non-OPEC producers Russia and Azerbaijan, which attended the Oran meeting as observers, to see if they announce expected cuts of 600,000 barrels a day. If so, total global output could fall by 3% and prices would be sent higher once more.
This would be great news for marginal producers like those operating in Canada's oil sands and the Saudis, who have recently invested in projects to expand production capacity from 10 to 12 million barrels a day. In case you missed it, a recent 60 Minutes profile on Saudi Armco is worth watching. Continued E&P activity will benefit oilfield service companies like Schlumberger, Baker Hughes, and Halliburton.
For American drivers, the question is whether you want super low prices now, and the potential for $4 to $5 a gallon gas in a few years time, or some stability around $2 a gallon. Whatever your preference, it's irrelevant: The choice will be made for us since, as a European Central Bank report noted, "OPEC is likely to enhance its control over markets over the next two decades."
Disclosure: The author does not own or control shares in any of the companies mentioned.
Anthony Mirhaydari is a contributor to the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.
Related reading:
Why oil is heading to $200+ a barrel
Why oil prices won't collapse further
Recession: Beginning of the end or just the beginning?
Can the Chinese still save us?
