As we have noted before, when oil prices are as low as they are now, OPEC members are in a classic prisoners’ dilemma. If they all adhere to production cuts, oil prices will be stronger as a result. But with governments badly dependent on oil revenues, the temptation to cheat is high. But if everyone cheats, the potential benefit of any cut is eroded.
Hopes for further production cuts at the next OPEC session appear to be fading. Nigeria has said they will not cut production further unless other members comply with October cuts. Are the two events related? Note the Nigerian oil minister took some pains to said that its statements did not indicate “a house divided.”
From Platts (hat tip reader Michael):
Nigeria would not reduce its oil output unless OPEC members implement the agreement for cuts made in October, Oil Minister Odein Ajumogobia said, state radio reported Thursday.
“At the last meeting, when there was a cut, we found out that a lot of countries did not comply, so,before we look at any further cut, we first want to be sure that everybody has complied,” Ajumogobia told reporters in Abuja Wednesday just before the weekly cabinet meeting.
From Reuters:
“Our primary concern at the consultative meeting will be the compliance of all members with previously agreed production allocation ceilings and to review market supply conditions,” [Nigerian] Oil Minister Odein Ajumogobia said on Thursday.
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Man, I was so wrong on this one. Learned to never trust numbers unconditionally, no matter the source, and that instincts are often just as useful as reason.
Gedankenexperiment:
Let’s say you’ve overbuilt your oil production capacity AND expanded your domestic population/infrastructure based on oil revenues.
In a declining consumption market you can:
A. Cut production and hope the other guys selling oil do likewise to increase the price (before you go broke).
B. Keep production steady, cut back on expenditures and hope the market rebounds (before you go broke).
C. Increase production to undercut the other players in the market, in the hopes that you can get more market share and drive them out of the business (before you go broke).
D. Form a global cartel.
E. Re-price oil sales in some useful commodity and hope the world’s superpowers don’t “liberate” you.
F. Bid up the price of oil futures and sell enough future production at artificially high prices to cushion the landing, then point and laugh as all the other (alternative?) energy producers go broke.
The fact that OPEC continues to lay away more and more capacity should at the very least serve to decrease the panic-induced, scarcity premium (if there even is such a thing).
The 1-year contango is now about $12, or over 20% return on spot oil. It’s insane.
I suspect that current spot weakness (compared to a 1-year forward price around $65) is a function of limited credit for working capital and margin for futures trades. Oil isn’t being stored because the financial firms formerly in the commodity storage game (Lehman, UBS, Morgan Stanley, Goldman) are either gone or curtailing their participation. Therefore, the marginal barrel now has to hit the spot market rather than go into storage. Combine this with lower Chinese storage subsequent to the Olympics, and, yuck. Ugly.
In short, it’s possible that spot weakness is a function of the credit crisis instead of anything related to supply/demand. If this is true, Opec can certainly cut production, but their ability to control prices is limited. Perhaps if they financed inventories…