can the oil cartel raise prices by cutting back production

cartel action in the offing?

That’s the rumor that has been supporting the oil price over the past week or so, despite this being the weakest season of the year for petroleum demand.  The story is that OPEC and Russia are having discussions right now about withholding output from the market in order to push prices up.

How likely is this to happen?

How likely is it that prices will rise if OPEC and others take action?

Supply/demand data

–world oil demand is about 95 million barrels a day, according to the International Energy Agency.  That figure has been growing at about a 1.5 million daily barrel clip over the past few years.  The IEA forecasts growth in demand to drop to a gain of 1.2 million in 2016, due to economic slowdown in China and the EU.  But demand will still likely be 96 million barrels/day by December.

–world oil supply is about 97 million barrels daily, according to the IEA.  That’s about 3 million barrels higher than at the end of 2014, due to increases in output from the US (2 million), Iraq (1 million) and Saudi Arabia (1 million-), partly offset by a bunch of production declines elsewhere.

–of the 97 million barrels of output, 39 million come from OPEC and about 14 from the former Soviet Union (11 million from Russia).  The rest come from oil consuming areas like the US, the EU and China.  These producers are, in my view, highly unlikely to cut output except when the selling price falls below the out-of-pocket costs of getting oil to the surface.

 

What I find fascinating about oil–and maybe this is just me–is the figures above show the gigantic fall in price since mid-2014 has been caused by a difference between supply and demand of only about 2%.  In fact, the IEA is forecasting continuing downward pressure on the oil price even though it thinks that the excess supply will be reduced to about 300,000 barrels daily, about 0.3%, by yearend.

It’s also important to note that demand for oil is relatively insensitive to changes in price over periods of a year or two or three.  Greater fuel efficiency of cars, substitution of natural gas or alternative energy, better insulation against heat and cold in construction, high taxes on fossil fuels in most developed countries (ex the US), are among the reasons.  What’s key for this discussion is that higher prices are very unlikely to make a dent in demand.  That’s a strong reason in favor of cartel action.

So, what would OPEC + Russia have to do to create a supply deficit?

…remove 2 million barrels of oil daily from world supply.  Let’s say 3 million, just to be on the safe side.  Given that OPEC + R control output of 53 million, that would mean each member reducing production by about 6%.  Assuming that increasing supply from US shale oil would only become economic at $40 a barrel, implying that’s the highest sustainable level prices are likely to achieve, OPEC + R could reap an almost immediate 25% increase in revenue by trimming output by 6%.  That’s a powerful incentive for economies radically dependent on oil sales and running short of cash.

Could this happen?

More tomorrow.

 

 

the weird relationship between stocks and oil

Over the past several months, there’s been a strong correlation between the movement of the crude oil price with the movement of stock prices around the world.  Oil goes up, stocks go up; oil goes down, stocks go down.

Until last week, there has been a certain logic to the link–a logic I think is incorrect, but a logic nonetheless.  Traders seem to be observing, correctly, that when economic activity is weak the demand for oil declines, both because consumers economize and industry uses less.  When that happens, the price of oil falls.  Therefore, traders say (incorrectly), the sharp drop in the oil price over the past 20 months is evidence that the world economy must be weaker than we think.  So low oil price = sell, or short, stocks.

 

Two problems with this line of thought:

–this is a little pedantic (actually, just skip over this paragraph), but logically “weak economy ⇒ falling oil price” doesn’t imply the converse, “falling oil ⇒ weak economy”.  It implies “not weak economy ⇒ not falling oil price.”  It’s like if you’re standing out in the rain, you get wet.  But if you’re wet, it doesn’t mean you’ve been standing out in the rain.  You may have been taking a shower.  Put a clearer way, the fact that a falling oil price is a symptom of economic weakness doesn’t mean it causes it.

–global demand for oil is, in fact, rising, not falling, according to the International Energy Agency.

 

Nevertheless, whether it makes sense or not to me, oil and stocks have been going up and down in lockstep.  So it makes sense to someone else–actually, a lot of someone elses.  And, like when it makes no sense but you see the train is barreling down the track at you, the best course of action is to step off the rails and out of the way.

That’s not the real weirdness.  Here’s where that comes in:

Over the past few days, oil and stocks have been going up on the rumor that a number of big oil producers, including OPEC and Russia, are talking about cutting back their production in order to prop up prices.

This would obviously be good for them.  If they’re getting $30 a barrel now and can move the price to $40 by reducing output by, say, 10%, their revenue goes up by 20%.  If the price got to $50, they’d be 50% better off than today.

However, this doesn’t make the world as a whole better off, nor does it stimulate the global economy.  It’s a transfer of money from oil consumers to oil producers.  It’s good for Saudi Arabia, Russia et al, but it’s bad for the US, Europe, Japan and China.  In the parts of the world the S&P 500 represents, it helps about 10% and hurts the other 90%.  So a rising oil price caused by cartel manipulation is a big net minus for the S&P.

Despite this, stocks soared yesterday, in robotic fashion according to the rule that stocks move in the same direction as oil.  Go figure.

the yen and the unraveling of Abenomics

Last week the Tokyo stock market had two days in which the benchmark Topix index fell by more than 5%.  For the week as a whole, the market declined by 12.5% (the quirky Nikkei 225, the Japanese equivalent of the Dow, fell by 11%).

This has little to do with worries about the oil price or about a global economic slowdown, in my view.  This is all about Abenomics.

The three “arrows” rhetoric aside, the idea behind Abenomics has been to create extraordinary short-term economic stimulus in Japan through huge depreciation of the currency, large increases in government deficit spending and a big expansion of the money supply.

It has been clear from the outset that all three of these actions will leave deep permanent scars on the Japanese economic landscape.  However, their purpose has been to buy time and space for export-oriented Japanese industry to restructure and modernize.  That would, in turn, allow these firms to hire more workers and increase wages for all.  In the eyes of Abe boosters, the benefits brought by a revitalized industrial base would more than offset the body blows caused by depreciation, inflation and an increase in already gargantuan outstanding government debt.

It has also been clear that Abenomics can’t take infinite time to work. Shock-and-awe stimulus is temporary; waves of it are progressively less effective.  Theory and practical experience both say that without substantive changes an economy tends to revert to its previous torpid state after a few years   …except there’s higher inflation.

In Japan’s case, industry hasn’t voluntarily restructured.  Government continues to protect recalcitrant corporate managements from outsiders skillful enough, wealthy enough and willing enough to take on the modernizing task.  So far, then, Abenomics has all been jam tomorrow, as Lewis Carroll put it.

Since the beginning of this month, early in the fourth year since the launch of Abenomics, the yen has risen by about 7% against the US$, 8% against the renminbi and about half that against the €.

This strength is a bit surprising, since it comes immediately after further stimulus by the Bank of Japan in the form of negative interest rates.  Investors in Tokyo are reading the currency strength as the first sign that the window of opportunity for Abenomics to succeed is starting to close.

I’m not sure this interpretation is completely correct.  But, having been an Abenomics skeptic from day one, I won’t argue that it’s wrong, either.

For people like me, who continue to watch from the sidelines, Japan is important to the rest of the world as a tourist destination, but mostly as a cautionary tale about the limits of monetary policy and the dangers of special interest politics determined to defend the status quo.