My OPEC Strategy
I was rereading Steve Levitt’s blog entitled “Peak Oil:” Welcome to the media’s new version of shark attacks” in preparation for the OPEC meeting (I’ll be the one wearing a Kaffiyeh) and I started doing a little math of my own.
In previous columns we’ve discussed the oversupply issues, the underlying reasons for oil’s rapid price increase and supply and demand issues - so here we will concentrate on price control options.
Using very round numbers so as not to annoy people I think it boils down to this:
The world uses 85M barrels of oil a day.
OPEC produces 30M barrels, Non-OPEC 55M
At $60 a barrel, OPEC makes $1.8Bn a day.
A 10% production cut (assuming it does hold the price) costs them $180M a day.
A $5 dollar a barrel drop in prices cost them $150M a day. They have to be reasonably certain then, that the benefit of cutting 10% of their production is greater than $5 a day or it’s a double loss.
Already it is 20% more profitable to let oil drop $5 in price than to cut production. Now, what if someone cheats within your group? They will put pressure on prices and take it directly out of your share. How much does Saudi Arabia trust Iran? Nigeria? Chavez?
Even if they all get along and sing Koom-Bi-Ya and cut production by 10% then what about their competitors? OPEC only supplies 40% of the world’s oil, the rest is supplied by FOREIGNERS! You know we can’t trust them….
It’s just not fair for OPEC to take a $180M per day hit in order to support prices so that their competitors can just swoop in and start supplying their customers.
And speaking of customers, those ingrates aren’t keeping up their end of the bargain! Not only are SUV sales off 40% in the US but the airlines have spent billions switching to lighter, more fuel efficient jets that can save over a billion barrels of jet fuel a year.
On the whole, demand is off 3.5% since oil first broke $50 in October of 2004. The US expects to produce 10Bn barrels of ethanol a year by 2010, that’s $600Bn less demand! Not only does 3.5% less demand cost OPEC $65M a day but if part of that $100M/day finds it’s ways into the hands of energy competitors (wind, solar, geothermal, coal, nuclear…) it could spur those industries on to grow and do better.
If we were to assume that this 3.5% drop in demand persists every 2 years that oil is over $50, then the first thing OPEC needs to do is get oil under $50 asap to stop the bleeding. Once you lose a customer, it is very hard to get them back!
So OPEC needs to come out of this meeting with a statement that they will cut back production quotas but not actual production and let us know they consider $50 to be a fair price for oil.
Rather than playing the villain, they could accept the inevitable and calm their customers, letting them know its OK to buy that SUV for the holidays.
Instead we can expect the usual greed and chaos to dominate the meeting which will leave the market on an uneven keel that will ultimately lead to OPEC, like Lucy and Ethyl, choking on thier own production.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW.
