OPEC Concerned Over Fall in Oil Prices

Jim Brown
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Iran's representative to the OPEC and president of the cartel for 2011, Mohammad Ali Khatibi, said any further declines in oil prices would require an "extraordinary meeting" of OPEC ministers to discuss quota reductions. That did not take long!

U.S. WTI crude prices declined from $98.60 to $83.60 in only a week and already OPEC is talking about holding a special meeting to discuss lowering quotas in order to push prices higher. Whatever happened to that "$85 is a fair price" mantra from last year?

Khatibi said he will decide if there is enough concern to hold the special meeting if oil prices continue lower. "Experience gains in recent years has shown that economic problems can have an impact on world oil demand and we should see if the crisis continues in coming weeks, then come to a comprehensive conclusion." It was good to hear he was not calling for a meeting next week but we have to remember OPEC is very political. By even discussing the meeting in the press it puts the world on notice that OPEC will not allow the price of oil to decline fro this level.

The next scheduled meeting is December 14th in Vienna. Oil prices declined by $5 on Thursday and they are down another $3 on Sunday night in response to the U.S. credit downgrade by S&P. Analysts are worried the downgrade and resulting slide in consumer confidence will cause a sharp slowdown in demand in the USA.

I don't believe we will see a material demand decrease because falling gasoline prices due to the drop in oil prices will be an incentive for some people to drive more. The minimal number of consumers who will drive less will be offset by the millions who will see $3.25 gasoline as a bargain and breathe a sigh of relief when they fill up.

The Wall Street Journal had an article this weekend that mirrored my comments in the other Oil Slick newsletter about the lack of demand destruction. The WSJ said the drop in oil prices was due to worries over a potential double dip recession and not because of any change in fundamentals. Harry Tchilinguirian, head of commodity strategy at BNP Paribas said "supply side risks have not disappeared. Middle Eastern tensions are ongoing while at the same time lost Libyan oil supply has yet to be replaced." Also, "Even though Western economies are struggling, oil demand is continuing to grow because it is mostly driven by emerging markets whose economies are still expanding."

Amrita Sen, oil analyst at Barclays Capital said the situation is evoking comparisons with 2008. Oil prices rallied to $147 as the world plunged into a recession then fell to $30 within the space of only a few months. Oil prices rallied in the spring and peaked in early May just as the "soft patch" appeared in the U.S. and fears of a double dip recession returned. Most analysts believe a repeat of that decline in unexpected. (Does that mean they expected the decline in 2008?)

Torbjorn Kjus, oil analyst at DnB NOR Markets in Oslo said, "I don't think we will see a repetition of 2008 unless there is a Lehman style credit crunch." I wonder if he has read the headlines about Italy, Spain and the U.S. credit downgrade? Events appear to be racing out of control in Europe with the ECB basically agreeing to print euros on Sunday in order to slow the death spiral of Italy and Spain. That would be the equivalent of QE1 for the ECB. Could it halt the death spiral is unknown. The situation is becoming increasingly dire.

In the U.S. the downgrade is more symbolic than material. However, there is the possibility for a continued market decline with the S&P futures opening more than 30 points lower on Sunday night. Consumer confidence is going to take a huge hit as a result of the downgrade but how much that translates into a spending halt is of course unknown until 6-8 weeks from now. The market decline over the last two weeks and the potential for a market decline in the coming week is a far bigger danger to consumer confidence than cutting America's credit rating by one notch. Americans equate their financial health and the health of the economy with the health of the stock market and right now the market is on life support and slipping into a coma.

If the ECB follows through on a plan to buy bonds from Italy and Spain in the open market the euro should strengthen and the dollar decline. This would support crude prices somewhat because they are denominated in dollars.

Also supporting prices was news NOAA has upgraded the expected severity of the U.S. hurricane season. In May they predicted a 65% chance of 12-18 tropical storms and 6-10 hurricanes. On Friday they upgraded that forecast to an 85% chance of 14-19 named storms with 7-10 hurricanes and up to five major hurricanes. The season has already seen five named storms with Emily the latest. Factors leading to the forecast upgrade included the third warmest waters in the Atlantic since record-keeping began in 1954. They also said the La Nina atmospheric pattern would likely redevelop in the coming months. There has not been a major hurricane in the oil patch since 2005 so we are due for a major hit. Once the first hurricane takes aim on the Gulf the price of crude will move higher.

The U.S. Chamber of Commerce warned its U.S. Energy Security Risk Index rose to 98.0 and the fourth highest since the index began in 1970. It also projects future risk through 2035 using the most current data from the EIA. They rate things like Middle East production, weather patterns in the Gulf, terrorist threats, rising demand, etc.

In a different survey by the American Journal of Public Health 75% of those Americans surveyed said that oil prices were either "very likely" (24%) or "somewhat likely" (52%) to TRIPLE over the next five years. Apparently the peak oil story is slowly sinking into the collective consciousness. Of those same survey respondents 65% said the tripling of oil prices would be "very harmful" to the economy and 44% said it would be "very harmful" to the health of Americans. I wonder if the health issue is because more Americans would stay home and watch TV while eating junk food since they can no longer afford to drive?

Jim Brown

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