The Implications of $10 Oil

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

OPEC is facing a dilemma in pricing.  It has lost control of its ability
to optimize oil revenue through a delicate balance of price and
production.  The non-OPEC producers, namely Russia, Mexico and Norway,
are playing an agressive game of fighting for market share.  Russia and
Norway, for very differnet reasons, can afford to survive a price war in
oil, surviving $10 oil for extended periods, certainly for longer than
the adverse impact of lost oil revenue on the domestic politics of most
OPEC economies.  Saudi Arabia is particularly fragile, since it cannot
afford to stop funding its geo-politcal obligations, and it needs oil
prices to stay above $25.

$10 oil will also hurt the already depressed energy sector in the US,
causing bankruptcies and cutting off future expolrations, paving the
path for preventing economic recovery by an energy induced inflation
whenever the economy shows signs of picking up.

Russia is trying its best to offer the US an alternative to Mid East oil
which may change the dynamics of US Mid East policy.  Putin's vision of
Russia as raw material supplier to an economically superior West will
inevitably run into domestic political opposition.

$10 oil will also pay a dividend in preventing any collapse of the
dollar.  It will also extract a cost of a protracted recession.

Henry C.K. Liu

Washington Post (11/14/01)
The Organization of Petroleum Exporting Countries (OPEC) warned today
that the global oil market could face a debilitating price war unless
rival producers, led by Russia and Mexico, showed greater cooperation in
curtailing output to help shore up sagging prices.

An emergency meeting of OPEC ministers at the cartel's headquarters in
Vienna broke up today with a promise to trim production by 1.5 million
barrels a day in January, but only if Russia and other non-OPEC oil
powers shared the burden by removing an extra 500,000 barrels a day from
the market.

"We will go ahead when we have a total cut of 2 million barrels a day,"
said OPEC's President Chakib Khelil. "We are not asking too much from
other countries. Why should OPEC alone continue to decrease supplies in
a way that only benefits non-OPEC?"

With the slumping global economy showing no signs of a quick recovery,
oil prices have been dropping steadily as demand among consumer
countries continues to shrink. Since the Sept. 11 attacks in New York
and Washington, prices have dropped below $20 a barrel after briefly
spiking up to $31 amid fears of war and political instability in the
oil-rich Persian Gulf region.

The potential oil glut could prove beneficial to Western industrial
economies by driving down energy prices. In recent months, gasoline
prices have fallen in the United States and Europe, and any price war in
the global oil market could provide an unanticipated boon to growth
prospects among consumer countries.

President Bush announced Tuesday that he would take advantage of lower
prices to fill up the Strategic Petroleum Reserve, which the United
States created to serve as an emergency source of oil. Bush said the
United States would add up to 100,000 barrels a day, which should help
to replenish supplies that were drawn down last year when the United
States sought to expand supplies in order to push prices below $30 a
barrel.

Some market analysts said the timing suggested a Bush administration
gesture of support to Saudi Arabia, an OPEC leader and key Persian Gulf
ally, at a time when it is helping the United States wage war in
Afghanistan.

"This could have been done two or three months ago," said Adam
Sieminski, an energy market analyst with Deutsche Bank.

Sieminski also warned that a free fall in oil prices could prove harmful
to Western economies in the long run. A collapse in oil prices would
hurt oil exploration and the development of new fields, resulting in a
shortfall in inventories and rising prices when industrial economies
rebound in the future.

The 11 OPEC members, which control about 60 percent of the world's oil
trade, have already reduced production this year in a futile bid to keep
prices within a target range of $22 to $28 a barrel. But their policy of
cutbacks has been foiled by rival producers who have seized the
opportunity to gain market share and enhance income at OPEC's expense.

The refusal by Russia, Mexico and Norway to sacrifice production in
order to push prices higher has frustrated the cartel's members, who
declared that unrestrained output could quickly drive prices to as low
as $10 a barrel ? a level that could prove ruinous to their economies.

Iran's oil minister Bijan Zanganeh said his country was not prepared to
cut "even one barrel" unless non-OPEC producers participated in serious
cuts. Other ministers said today's decision to postpone a 1.5 million
barrel a day cut until the cartel's rivals take similar action reflected
a common belief that OPEC could no longer be expected to manage the
market on its own.

"I'm afraid that this cut without [non-OPEC producers] will not help,"
said Qatar's oil minister Abdullah Attiyah. "It will be useless and then
I'm afraid that this will push us to enter a price war and it will be a
disaster for everybody."

Norway and Mexico have refused OPEC's pleas to cut output partly out of
sympathy with the view among some consumer countries that oil prices
should fall further in order to boost prospects for a global economic
recovery. Russia, which now pumps 7 million barrels a day and has
emerged as the world's second biggest oil exporter, has declined to
offer anything more than a token cut.

But Saudi Arabia's oil minister Ali Nuaimi, who visited Moscow last week
seeking to win greater cooperation, said he still hoped to persuade the
Russians that a temporary production cut would serve their own economic
interests.

Nuaimi said the Russians have "the biggest capability and thus they are
the key to price stability." He stressed that unless Moscow could be
convinced to offer help in managing the market, it would prove
impossible to keep oil prices above $20 a barrel.

The tension showed how weak OPEC's position has become at a time of
diminishing demand for oil among consumer countries. "The loss of market
share by OPEC has reached a critical level," said Lawrence Eagles, a
global oil analyst with GNI Research. "Clearly OPEC cannot continue to
cut output and lose market share indefinitely. But at what point are
they prepared to say enough is enough? They may be squaring up for a
fight, but are they prepared to see it through?"

The severity of the downturn in the United States, Japan and Europe
caused global oil demand to fall by about 750,000 barrels in the third
quarter ? the largest quarterly drop since the 1990 Gulf War. The
International Energy Agency predicts demand will continue to slide over
the next nine months, which would be the longest sustained fall in
demand since the mid-1980s.