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OPEC’s Perfect Storm

A wave of selloff in the financial markets worldwide followed rising concerns about growth in China. This is the worse timing imaginable for the oil market. Prices were already low and heading south under presuure from the known market glut. Stocks are at record high levels. And prospects even before the last market shake, were not encouraging.

According to some estimates, OPEC producers lost $500 million in the year ending May 31. This huge amount of money has been moved from the bank accounts of the producers to the accounts of the coffers of the governments of the consuming countries. In Europe, for example, end user prices of refined products did not change much in spite of the fall in crude prices. The moment a barrel of crude crosses the borders of most EU countries, its price are lifted to a certain level preset by regulators. The actual price paid to the producers have very little impact on the end consumer bills. Therefore, while the producers lose quite a bit of their revenues, the end consumer does not enjoy any comparable benefit. Much for a global free trade system.

Imposing similar taxes on European manufactured products imported by oil producers to address this unfair trade practice is a thorny issue in the current “fair” global trade system. Such taxes are considered a breach to the World Trade Organization’s “constitution”. The issue, which is theoretically discussable based on the principle of equal treatment, is a taboo in the global trade arena. It is met with “reminders” of security relations, strategic calculus and political considerations. Repeated injustice turn sometimes, somehow, to just the norms.

However, even within the frame of the current “fair” trade system, OPEC is about to lose even more compared to its revenues three years ago. That raises the question of who really owns the oil wells if the importing governments make much more profits of oil trade than the very owners of these wells.

For the time being, the pressing problem is the collapsing prices. The next scheduled meeting for OPEC is not until next December. Yet, there are voices warning that if there is no immediate intervention from the producers club, the damage they will incur will be far greater than that of last year. These warning voices have one address in mind: Saudi Arabia. “Emergency intervention” always mean reducing  Saudi Arabia’s output.

But will Riyadh accept an emergency OPEC meeting knowing that the only objective for such a meeting is to cut production?

There are arguments supporting both sides of the answer.

OPEC hawks will not move Riyadh. They never have. But Saudi close allies in the Gulf are not happy now with what is going on in the market. Kuwait showed its frustration in its public fight with Riyadh around a couple of shared fields. Others are quietly complaining.

Furthermore, there is growing pressure inside Saudi Arabia itself to do something to stop the fall of oil prices. Saudi budget needs a $100 per barrel at least to be balanced. Reserves are finite and lower prices are already reflected on public spending.

Thinking of oil as a weapon to influence Iran’s domestic situation is getting less and less meaningful now in the post nuclear deal environment. Iran will receive substantial funds once the sanctions start disappearing. Lower prices nave even longer way now to produce an effect in Tehran, if they will ever do.

But it is too late now for an emergency OPEC meeting to do anything meaningful. Even if Saudi Arabia decides to go the way of the hawks and please its close allies, this decision will hardly make a difference. It will result in Saudi Arabia losing clients to other producers while prices continue their journey south nonetheless. Riyadh cannot make a U-Turn in its production policies now, and if it does, the market wouldn’t care much. The glut has been here for some time now, and additional capacities are getting ready to make it even worse. Iraq and Iran are two good examples. Lower prices cannot go low enough to shut their wells. Who in his right mind can believe that Riyadh may give up part of its market share to the Iranians, without even hoping for better prices?

Better prices presuppose increasing demand. The financial market and prospects of growth in the emerging markets plus China are not green for the black gold these days. Without a substantial increase in demand there is no hope for absorbing the additional capacities or stocks.

The timing of a decision to lower production is as sensitive as the timing of the decision to increase production. While strategic concerns were not the only reason behind increasing production, it will certainly not be the only reason to reverse directions.

Global macros do not look reassuring to inspire that demand will increase anytime soon. China is using regulatory tools to cure shortfalls that are not caused by regulations. This is bad for now but worse for the future. Central Banks are exhausted and they cannot keep the financial bubble bubbling forever. Prospects for Europe are not bright due to structural distortions that everybody pretends do not exist.

Briefly, who expects an improvement in demand in the short term? Even a reduction in production levels, though not expected either in Iraq or in Iran after the deal, will hardly be noticed by price charts. The glut and the stocks are such that you need to shut down several giant fields in and out of OPEC before the market can hear any noise.

Moreover, without a kind of coordination with non-OPEC major producers, an emergency meeting for the organization will be self-damaging. Even if OPEC members decides to stop cheating in their quotas, honest to God, the non-OPEC producers have no binding agreements with the organization. We have seen that kind of coordination before and it is certainly needed now. But that wouldn’t materialize in a matter of weeks or even months. A draconian plan to gather the elements of a fair deal within and without OPEC, is needed but not anywhere to be seen. Yet, the effect on prices, even after such a plan, are not certain. We have quite a bit of surplus capacity and quite a bit of decrease in demand and quite a bit of domestic pressures on producers, like Iraq, to continue pumping more. It is the perfect storm for OPEC. The worst possible scenario is happening.

But what is bad for some is good for others. EU governments must be gazing now on their calculators with some plans to celebrate later in the evening. If it is a good Bordeaux, maybe, just maybe, it will justify the good news.

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