How Crude Oil’s Plunge Has Decimated OPEC

Since peaking at around $107 per barrel back in June, crude oil prices for West Texas Intermediate (WTI) grade have plunged all the way to near $60. The collapse over the last six months has been stunning.

I know of no forecaster that saw a decline of this magnitude coming. Both WTI and Brent crude are down nearly 40% from their June highs, putting them firmly in bear-market territory.

There’s an old saying in the commodities world: “The solution to high prices is high prices.” The inference here is that if the price of a commodity gets too high, it will stimulate alternative means of production that will eventually result in a large increase in supply. That is exactly what’s happened.

WTI crude futures plunged by 4% yesterday alone to an intra-day low of $60.55 before rebounding to above $61.  The catalyst was the latest report from the US Energy Information Administration (EIA) which showed that crude oil stockpiles were up 1.45 million barrels last week, against expectations for inventory to drop by 2.2 million barrels.

In short, there was an increase in stockpiled crude inventory last week, despite the fact that prices haven’t been this low since 2009.

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Yet while US crude inventories rose last week, there are clear signs that today’s low prices will lead to production cutbacks in the months ahead. Reuters reported yesterday that falling oil prices have started to affect US domestic production, with the EIA cutting its forecasted growth by 100,000 barrels per day, a move linked to generally weaker oil demand.

In its latest report released Wednesday, OPEC also reduced its global demand forecast to 28.9 million barrels per day, the lowest since 2002. Increased US production and decreased demand have been cited as the culprits for crude’s rapid decline over the last several months.

The Death of OPEC

Bank of America’s commodity chief, Francisco Blanch, declared this week that:

The OPEC oil cartel no longer exists in any meaningful sense and crude prices
will slump to $50 a barrel over the coming months as market forces shake out
the weakest producers. [OPEC is] effectively dissolved after it failed to stabilize
prices at its last meeting. The consequences are profound and long-lasting.

blog141211bFor the first time in a generation, OPEC is losing its iron-fisted grip over the political economy of petroleum. At the latest meeting in Vienna in late November, OPEC officially decided not to cut production (30 million barrels per day) in what would have been an attempt to keep global oil prices from falling any further. Prices plunged on the decision.

Several members of the cartel wanted a decrease in production, but Saudi Arabia is said to have blocked it. That means that oil production will remain at the current level until June of next year when the next meeting of the cartel is scheduled – unless an emergency meeting is called in the interim – a good possibility.

The thinking by Saudi Arabia and other members who voted against a decrease reportedly was that cutting production by some producers will only lead to a reduction in market share, without realizing any meaningful longer- term support for prices. These are not rocket scientists or astute commodity traders; if they continue to produce more than the world can consume, then prices will almost certainly continue to move lower.

There was also fear that any production cutback by OPEC could easily be filled in by the US and Russia. OPEC has not faced such a dilemma before. It is this cocktail of trouble which is weighing on OPEC, an organization which has managed to survive past crises by manipulating production to achieve their desired change in oil prices.

With so many OPEC member countries now in financial crises due to plunging oil revenues, I believe that the cartel is effectively dead.

One final thought on oil: Keep in mind that commodity prices tend to move too far in both directions. While many now assume that crude will move to $50 or lower, I would NOT want to be short oil at the current level near $60.

On an unrelated note, you have no doubt heard about the so-called CIA “torture report” which was released on Tuesday and the bitter controversy it has caused. The Democrat authors of the report say that the CIA torture techniques didn’t work. Before you buy that conclusion, you should read the following interview with a former senior CIA official who was there at the time.

Read interview Jose Rodriguez: CIA Thrown “Under the Bus”

Do you agree with me that OPEC is dead? Let me know your thoughts.

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