OPEC is in a Pickle, Thanks to U.S. Oil Producers

This article was published by The McAlvany Intelligence Advisor on Monday, November 12, 2018:  

In this space a week ago, this writer panned King Hubbard’s “Peak Oil” theory as fracking technology and favorable market conditions for U.S. producers continued to drive world crude oil prices lower. In early October, the price of oil for November delivery was over $76 a barrel. At the market close on Friday, November 2, the price for December delivery was below $63, pushing the oil market close to bear market territory.

The oil market continued its remarkable decline, with December oil futures trading at the close on Friday, November 9, below $60 a barrel.

This has gotten the attention of the oil ministers of OPEC and its hangers-on (like Russia and Oman), and on Saturday they held an emergency meeting in Abu Dhabi, UAE to see what could be done to stop the decline. On Sunday, Saudi Arabia’s oil minister told Oman’s oil minister that, come December, the cartel will cut oil production by a million barrels a day.

Everything was running along smoothly right up through August. As the day of reckoning for Trump’s imposition of sanctions on Iran’s oil exports – November 5 – drew ever closer, oil prices moved ever higher. The calculation was simple: those sanctions were going to take a million or more barrels of Iranian oil off the world market, and crude oil prices were going to go higher, perhaps much higher. Some were estimating $100 a barrel by the end of the year, helped along by comments from Secretary of State Mike Pompeo that the sanctions would really damage the Iranian’s cash flow. Oil traders placed their bets accordingly.

But just days later, the State Department reconsidered and issued waivers to eight countries, allowing them to continue to purchase oil from Iran after all. That effectively cut the legs out from under those investors, who immediately reversed their positions, driving oil prices into a bear market.

Instead of a dearth, there’s now every likelihood of a glut. OPEC now looks at the world much differently. China’s economy is slowing, thanks partly to internal mismanagement and the adoption of Keynesian economic policies (“You can spend your way into prosperity with borrowed or created money”) and thanks partly to the growing threat of tariffs by Mr. Trump. At present, those tariffs affect about half of China’s exports to the U.S., and only at 10 percent. But come the end of the year they will jump to 25 percent. And if the meeting scheduled in Buenos Aires later on this month between the president and China’s communist leader Xi doesn’t go well and no agreement (or even a hint of one) is reached, Trump has clearly stated he will apply tariffs on the remaining $250 billion of Chinese exports that so far have escaped the penalty.

Other reports on slowing worldwide trade (and the consequent declining need for energy) are adding to OPEC’s angst. To say nothing of what’s going on in America’s oil patch.

Not only is America now the world’s largest producer of crude (ahead of both Saudi Arabia and Russia) but as the pipeline bottlenecks are being eliminated (there are six new or expanded pipelines leading out of the Permian Basis and Eagle Shale oilfields currently nearing completion) that will allow an additional four million barrels of oil to flow in less than two years. In addition, the rig count in America’s oilfields has nearly tripled since May 2016, and there are 5,575 DUCs – wells that are drilled but not completed – just waiting to be added to oil producers’ production.

The net result of all of this? OPEC is in the classic baseball “pickle.” Otherwise known as a rundown or the hotbox, a player is caught between two bases (known as “no-man’s land”) and has the other team’s players closing in on him. Only in rare cases does he reach the safety of a bag before being tagged out.

If OPEC makes good on the Saudi oil minister’s threat and persuades the cartel in December to cut production by a million bpd, oil prices will go up. At least in the short run. But in the long run? Let’s let Adam Levine-Weinberg of The Motley Fool explain:

In the short term, production cuts by OPEC and its allies could drive up prices. But in the long run, any such moves would be self-defeating. U.S. oil production is primed to keep skyrocketing – the higher oil prices go in the short term, the bigger the jump in U.S. [crude oil] output will be.

The cartel faces two primary problems. One, the U.S., now a major oil producer, has no interest in playing the cartel game. It is doing just fine without joining a cartel in order to protect its market share or its profitability. Two, OPEC is facing pressure from its members to dissolve the cartel altogether and let each producer stand on its own. The Wall Street Journal reported last week that a Saudi-funded think tank, the King Abdullah Petroleum Studies and Research Center, has been studying a scenario under which OPEC would disband.

Put another way, the think tank is studying the unthinkable: a free market in oil. Said the Saudi oil minister: “Think tanks like to think. We won’t discourage them from thinking … [but] we believe that any professional study by [them] will show that the combination of cooperation and mitigating extreme volatility [in the world’s oil markets] will be the best for the market.”

This is known as “whistling past the graveyard.” This is what people, and cartels, do when faced with existential threats.

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Sources:

The McAlvany Intelligence Advisor: So Much for King Hubbard’s “Peak Oil” Theory

The Wall Street Journal: OPEC Edges Closer to Production Cut as Saudis Signal Intent

TheNational.ae: OPEC to convene in Abu Dhabi amid worries over surging US crude supplies

IrishTimes.com: OPEC and allies meet amid sinking prices and calls to cut output

The Motley Fool: A Texas-Sized Surge in Oil Production Will Hold Prices Down

Baseball’s “pickle”

Whistling past the graveyard

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