A Nasty Economic Virus
Making the right bold decision is an art. During this severe global economic downturn, which is spreading around like a bad virus we tend to become numb to big announcements -- from record investment fund fraud in New York of $50 billion to record interest rate cuts.
It is within this context that the members of OPEC followed right on the heels of the members of the U.S. Federal Reserve Board with a historic move. As their policy counterparts at the Fed know, chasing the market is proving difficult, because consumer sentiment and therefore demand is plummeting so fast.
A cut of 2.2 million barrels a day is dramatic, especially in the context of a $100 drop in a barrel of crude in the last six months. By OPEC standards this was managed in a measured way.
After convening an emergency meeting in late November in Cairo, the group gathered in the home country of the cartel’s president, Chakib Khalil. They were joined by four non-OPEC counterparts as observers from Azerbaijan, Oman, Russia and Syria. They, too, sent signals that cuts in January 2009 would hit the market. Some production was scheduled to come off anyway, but in this case producers wanted to illustrate unity.
The reason for this sudden cosiness in the oil business is simple, a sharp drop in revenues. OPEC nations have lost nearly $3 billion a day since the peak in July; they lost half their daily revenue since the start of the year. Forty to fifty dollars a barrel is not what this group has in mind especially when there is more than $1 trillion of projects either under construction or on the drawing board in the Middle East.
The reality is OPEC members were left with little choice than to take action. Prices dropped a record $28 in the month of October. It was like the global economy was walking tentatively along with concerns about recession, and then plunged off the cliff into crisis. This rings true in nearly every sector: oil, autos, housing and shipping.
I spoke to a representative of one of the largest oil and gas shipping groups who noted tanker rates plummeted 80 percent for shipments since July. No one can remember that happening in recent memory.
As a twenty year veteran of covering OPEC meetings, it also strikes me as rather extraordinary that the dramatic action was taken right in the midst of winter when demand is about to hit its peak. Respected energy consultant, Mehdi Varzi, is one who believes OPEC is acting in a near-sighted way. He sees the global economy right now as a very ill patient and higher prices will only prolong the illness or extend the recession in this case.
Varzi for one believes we could see $60 to $70 oil by the spring. This is in line with the aspirations of Saudi Arabia, Kuwait and Qatar but not high enough to prompt companies to invest in marginal fields or fund alternative energy projects either. It is the “Goldilocks scenario” we talked about recently on our program and in this column.
When that OPEC target price will be reached is a subject of great debate within the corridors of oil companies, investment houses, buyers of energy and the analyst community. Fareed Mohamedi of consulting group PFC Energy in Washington believes a price around $70 a barrel will be postponed until 2010, due to a mix of poor market sentiment and a real drop in demand. “People think we are going to go down before we go up,” says Mohamedi, and there is a “lack of trust they will deliver.”
After a full day of reporting on OPEC’s historic cut on paper, I was called by a friend who has worked in the Middle East for 20 years and was eager to mull over the action taken by oil producers. He correctly pointed out that OPEC never manages what he calls a falling market. If downward momentum begins to build, it is very difficult to turn the tide or even set a floor underneath prices. This was true in the late 1980’s (I can remember seeing for myself the rusting oil rigs in Texas fields) and again earlier this decade when recession set in.
This sell off as both Varzi and Mohamedi discussed during our interviews is more severe than anything we have witnessed in the past two decades. The market went from a period of great exuberance to great concern in a span of just three months.
The oil market and the cloud of negative sentiment that persists is a reflection of the global economy today as a whole -- it just took much longer to hit this sector. A year and a half ago the U.S. housing market started to expose real cracks of concern, followed by the sub-prime crisis during the late summer of 2007. Six months ago we were still witnessing record oil prices, which lulled ministers into believing that demand from the East would outweigh problems out West.
A full year later after the financial crisis everyone, including those who sat around the table in Algeria, found out the hard way that no one or nothing is immune from this persistent, nasty economic virus.
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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