more oil production cuts announced

the news

Over the weekend, a group of non-OPEC oil producing countries, including Russia and Mexico, announced they will pare their collective crude oil output by 500,000 daily barrels.  About 60% of the total reduction will come from Russia.

On hearing that, Saudi Arabia said it would reduce its liftings by more than its already-promised 486,000 daily barrels.  The kingdom didn’t specify an amount, however–and the wording of its statement suggests the number will be small.

Nevertheless, the combined declarations have been enough to raise the price of oil in commodity trading by about 5% today, and 10% in total.

To put these figures into perspective, world crude production is around 98 million barrels per day.  So we’re talking about less than a 2% reduction in total output.

for oil producing countries

In one sense, the agreements have already been a financial success for the countries involved.  For most, they’ll reduce future output by, say, 2% and are already receiving 10% more for the 98% they are still selling.  That combination brings in 8% more dollars.

On the other hand, a $50+ price per barrel gives new life to shale oil producers in the US.  All to that that a fracking-friendly administration in Washington and the likelihood is that crude oil output from the US will begin to rise rapidly next year, offsetting at least some of the near-term output reductions now being achieved.

for investors

For us the situation is not so clear.

–Oil exploration and development companies in the US have already risen substantially on the original OPEC cutback announcement

–We’re also only about six weeks away from the beginning of the seasonally weakest part of the year for oil.  Crude oil bought in late January can’t be refined into heating oil and delivered to retail customers before the winter is over.  The driving season doesn’t begin in earnest until April.  So demand for the two principal refined products will be at a low ebb from January – March.  Soft demand usually translates into weaker crude prices.

–At some point, we’ll begin to see US crude output pickup

–The promised output cuts won’t take effect until the new year, so it’s impossible to find countries cheating on their output reduction pledges today.  The history of all commodity cartels tells us, however, that cheating will happen.  And if past is prologue, evidence of cheating will trigger a substantial price decline.

So we can reasonably expect a substantial bump in the crude-can-only-go-up-from-here road shortly.

Although I’m not doing anything at the moment, my reaction to all this is that I’m closer to being a seller of oil exploration firms than a buyer.  If I had a relatively large position (I don’t.  I only own one e&p stock), I’d be trimming it today, with an eye to possibly buying back in late January.





Russia as the new Malaysia?

To me, what made Malaysia noteworthy during the Asian financial crisis of the late 1990s was how vigorously the country defended the interests of a small cadre of insiders who had amassed mega-fortunes over the prior decade or more.  Political connections + aggressive use of financial leverage–after all, what local bank would deny them a loan?–were the keys to  their success. In the end, Kuala Lumpur imposed capital controls lasting about a year to prevent foreigners from selling assets and withdrawing the funds from the country.  That action gave Malaysian financial markets a long-lasting black eye, something that could have been avoided if Malaysia had chosen to raise interest rates to achieve the same end instead.  But doing so would have bought down more than one of the local moguls.

In current crisis among oil-producing countries, Russia is already taking the first step down the Malaysian path.  Last week Moscow orchestrated a $11+ billion sale of bonds by oil giant Rosneft.  The issue had a coupon below that of government debt.  It was reportedly taken up mostly  (entirely?) by state-owned banks.  The central bank promptly declared itself willing to accept the bonds as collateral for loans to be made at rates below the bond coupons.  Indirectly, then, the funds Rosneft raised come from the Russian equivalent of the Fed.

That President Putin should protect his cronies shouldn’t come as any surprise.  But if this is a chief aim of his government, which it appears to be,  investors have to at least consider the possibility that Moscow may be forced to impose capital controls at some point.  For you and me, this implies checking to make sure we know what exposure we may have through emerging markets or yield-hungry fixed income funds/ETFs.