Monday, September 25, 2006

Wither the price of oil 

Of late the price of oil has been in the news quite a bit. After having spiked up to the mid $70 range it has fallen back to about $60 per barrel. Venezuelan oil, which sells for about $10 per barrel less than the prices you hear quoted in the paper, is now selling for $52 per barrel. The Venezuelan opposition are besides themselves with glee. If the price of oil falls maybe Chavez will fall with it, or so they hope

Unfortunately for them this hope is likely to be dashed. First a little perspective. One of the most common mistakes people make is to project current conditions back in time and assume that if Venezuelan oil is selling for a lot of money now it has been selling at very high prices during all of Chavez’s tenure. That is not the case.

In 1998 before Chavez came to power Venezuelan oil was selling for a rock bottom $8 per barrel. With OPEC production cutbacks in 1999 the price tripled to about $25 per barrel. And from there had an interesting evolution:

2000 $25.91
2001 $20.18
2002 $22.18
2003 $25.65
2004 $32.61
2005 $41.39

And year to date in 2006 it is averaging $58.43.

So looking at these numbers is there great cause for concern because of the current fallback in prices? As long as prices don’t go a LOT lower the answer is clearly no. For instance, at $52 per barrel the price of oil is currently $9 more than what it averaged in 2005 – and in 2005 the opposition was complaining bitterly about what sky high oil prices Chavez was having the good fortune to enjoy. And at $52 the price is almost $20 more than it was in 2004 when Chavez was able to start the massive social programs called Missions and start the economy on its present path of very rapid growth.

Thus when looking at the actual numbers rather than getting caught up in the media hype we notice the price of oil, compared to what it was as recently as last year, is still quite high and if it were to remain at this level or even close to it the Venezuelan economy would likely remain quite healthy. In fact, even if the price were to go lower the Venezuelan government isn’t going to run into a cash crunch anytime soon. They have $35 billion in their foreign reserves and $17 billion in their National Development Fund. In addition to that $52 billion various government ministries have billions more dollars that they have been allocated but yet to spend. All that is not to even mention that Venezuela now has less debt, a bigger economy, a healthier tax base, and an economy with lots of momentum (over 9% growth currently).

In an indication that Chavez himself isn’t fazed by the recent price changes and today said yesterday that he was quite happy with $50 per barrel oil.

That makes the real question is it possible the price of oil will go MUCH lower – down to $30 per barrel for example? Where oil is going is very much open to debate. Some think the recent run up in price results at least in part from speculative hedge funds investing in oil. If that is true and those funds start selling oil its price could indeed plummet.

Further, data for months now have confirmed that world oil and gas stocks are high and have been rising. That alone indicates that there is more supply than demand and prices should drop. So that also points to lower prices.

There is though another big factor in all of this: OPEC. That organization, which exists to garner higher oil prices for exporting countries by restricting production, probably won’t sit idly by as prices slide. The question is when will they act, what will they do, and will it be enough. The Wall Street Journal had an article exploring precisely that. What follows are some exerps:

Will OPEC Protect Its Cash Cow?

By Bhushan Bahree
September 22, 2006

The slide in oil prices is setting up a battle within OPEC over when to cut output and who should bear the pain of doing so, a ruckus that could roil crude markets in the days and weeks ahead. The debate comes as crude has tumbled sharply since midsummer, amid a softening world economy and a drop-off in big oil-supply outages. Unresolved, the tensions could intensify an rout in prices as members of the Organization of Petroleum Exporting Countries duke it out for market share. Several OPEC ministers have said the cartel will likely need to slash supply early next year.

But a continuation of the price slide could compel OPEC to act much sooner, possibly even in the coming days.

OPEC may ask member countries to cut from current production now, leaving the thorny quota discussions for later, one senior OPEC official said Thursday. If prices are falling fast, this official added, OPEC may also ask such nonmember countries as Mexico and Norway to restrain their output, as the cartel has done in years past when prices plummeted. Of course, if markets become convinced OPEC is poised to cut output, prices could stabilize or even climb again. A surprise supply outage could have the same effect.

How OPEC plays the market is crucial, as the cartel provides one-third of the world’s oil supply. OPEC’s own technical analysts say markets are already oversupplied and prices could continue tumbling


Adding to the complexity is a lack of consensus in OPEC about what price level to defend. Many ministers have indicated that OPEC’s line in the sand could be $55 barrel for U.S. benchmark crude [this corresponds to about $45 for Venezuelan oil – ow]

Cartel officials and some independent analysts say prices could fall to $50 a barrel, even $40, if bearish sentiment grips the market, financial investors cash out of oil-futures contracts and OPEC is slow to cut production.


Last week, OPEC scuttled its quota allocations, which had been fixed at a total of 28 million barrels a day. Instead, the cartel urged members to adjust production on their own to match demand for their oil. This will allow OPEC to trim output quietly.


Crucial to any decision to cut will be Saudi Arabia and its oil minister Ali Naimi, de facto leader of OPEC. The kingdom accounts for nearly 30% of OPEC output, and any decision would have to be backed by the Saudis to work.

In Vienna, Mr. Naimi wasn’t naming the price at which he would back cartel-wide cuts. But on Tuesday in Riyadh, when the prices were falling towards $61 a barrel, he offered a clue. Mr. Naimi told reporters, “The oil industry is convinced that this price is reasonable,” according to Reuters.

Clearly OPEC is already starting to take action. Whether it will be in time to prevent an even sharper drop in prices only time will tell. But one thing that is quite heartening in this article is that it seems OPEC sees prices in the $50 or $60 range as worth defending. This is quite a sea change. Again, remember back to how things were in 2000 and 2001. Then OPEC, at Venezuela’s request, implemented a targeted price range of $22 to $28. That price band now seems to be closer to $52 to $58 even amongst the Saudis who have historically been one of the weak links in OPEC.

What is the bottom line in all of this? Simple, OPEC needs to continue cutting back on production, Russia and Norway should think about doing the same, and the Venezuelan opposition shouldn’t get their hopes up – Venezuela is likely to keep doing just fine.


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