Editor’s note: The price of crude oil has dropped 25% as of October 6, 2006, after topping out in early July. The fall in price, in and of itself qualifies as a bear market, although few in the media are talking about it, in those terms, just yet. Normally, from a psychological standpoint, bear markets tend to continue until there is a feeling of panic in the air, and the majority opinion is that prices will never rise again. As far as we can tell, there is none of that as of this writing, which means, if history holds true, that the price of oil may still go lower. OPEC is not known for its discipline, as far as adhering to production quotas. And true to form, the cartel is once again waffling when it comes to making decisions that would presumably hold the line on prices. In this analysis, Dr. Duarte examines two key events that suggest that there may be a power struggle within OPEC, and that the financial markets have little confidence in the cartel’s ability to act in either a timely or effective manner with regard to production cuts. The analyses highlighted below appeared on www.joe-duarte.com, on October 3^rd and 4^th, and 6^th 2006.

OPEC Gets No Respect (10-6-06)

Like the late comedian Rodney Dangerfield, OPEC is getting no respect.

One day after the cartel announced an "informal" production cut of 1 million barrels per day, crude oil slipped below the key $60 support level, in overnight trading.

According to AFX News Limited, the price drop came in response to "doubts the OPEC cartel will come to an official agreement over output cuts before its December production meeting."

In other words, despite the fact that Nigeria, Venezuela, and Kuwait have cut production, the market, trained to believe that OPEC will always cheat on its output quotas, is having none of it this time.

In fact, despite widely disseminated reports on 10-5, about production cuts, according to AFX:

"OPEC president Edmund Daukoru said the group was considering holding an emergency meeting before its Dec 14 conference to discuss output cuts," but Daukoru "failed to confirm or deny a slew of reports attributed to anonymous sources from OPEC member countries who said the cartel plans to trim its daily production by 1 mln barrels."

More interesting is the fact that "press reports cited Nail al-Jubeir, a spokesman for Saudi Arabia's US ambassador, as saying there is no plan in Riyadh to crimp supplies in order to prop up prices."

AFX quoted Societe Generale analyst Frederic Lassere as saying: "the market is surprised the cartel, supplier of more than a third of the world's crude oil, had not come up with a plan, when prices were high, for what to do in the eventuality of price declines," and 'They are not prepared at all. They are having a debate that is more or less public -- which is never good -- so the market will react negatively, it feels it will take time before OPEC is in a position to implement cuts.'

Kuwait's Power Play (10-4-06)
A Test For OPEC

Crude oil prices soared in pre- U.S. trading as OPEC, at around 5:25 central time, announced that it would cut oil production by 1 million barrels per day. The announcement comes on the heels of a public show of discord amongst cartel members, which is worth watching.

This story has been in the making for the last few days, though, as on 10-3, Kuwait announced its support for oil production cuts put forth by Venezuela and Nigeria. The act is a significant change for the Gulf oil producer and suggests a potentially significant sea change in the cartel.

According to the Kuwait Times.net: "Core Opec producer Kuwait may join Nigeria and Venezuela in cutting its oil output if prices continue their steep drop, Kuwaiti Oil Minister Sheikh Ali Al-Jarrah Al-Sabah told Reuters in an interview yesterday."

The paper added: "His comments were significant because Kuwait is the first of Opec's Gulf members to take this position. US oil prices rallied almost 50 cents to above $59 a barrel. Top exporter Saudi Arabia and its Gulf neighbours Kuwait and the United Arab Emirates have most of the world's spare oil output capacity and are best placed to raise output when needed."

Seeking To Become A "Market Mover"

Yet, there may be more to the Kuwait story, despite its assertions that for now it agrees with "OPEC ministers" that all production cuts should be "voluntary."

According to Stratfor.com: "the Kuwaiti statement carries more weight," than similar utterings from Venezuela and Nigeria, the first two OPEC countries to announce production cuts. Kuwait, Stratfor points out, is the third-largest crude producer in OPEC, behind Saudi Arabia and Iran. As of August 2006, it was producing 2.6 million barrels per day (bpd) -- 400,000 barrels more than its OPEC-assigned 2.2 million bpd quota. Hence, Kuwait can afford to act on its threat to cut production," while Venezuela and Nigeria, who are suspected of inflating their current production numbers, are not likely to cut production in reality.

Stratfor added the following: "The statements from Caracas, Abuja and Kuwait City betray their desire to become "oil market-movers" -- a title that Saudi Arabia has claimed as its own for years. " In other words, if Stratfor is correct, then other OPEC members are attempting to curtail the influence of the Saudis on the oil markets and on the cartel itself.

Indeed, there were inklings of a turf war, prior to the announced production cuts on 10-4, as the Kuwait Times noted: "Some analysts have questioned Opec's ability to speak with one voice since Nigeria and Venezuela announced token output cuts to stem oil's rapid decline."

Conclusion

The announcement of production cuts by OPEC is significant, since it occurred without an emergency meeting, and without much fanfare.

The markets have been voicing their doubts about the cartel's ability to do anything but talk about production discipline, but perhaps, old guidelines are not as trustworthy as they once were.

For one thing, Kuwait seems to have made some significant strides as a major influence on the cartel.

And, why not? According to Stratfor.com: "Kuwait's geopolitical position has become less secure since the Iraq war. Kuwaiti border police and Iraqi militants have been clashing, and Iran's growing bellicosity is proving worrisome for Kuwait, which has a significant Shiite minority. The Kuwaitis would feel more secure if they had an extra "lever" on the international stage; being an oil market-mover can fill this role and increase Kuwait's value in the eyes of the United States."

Indeed, the consequences of the Iraq war continue to be extremely unpredictable.

OPEC: Playing Chicken (10-3-06)
What Production Cuts?

OPEC is playing a dangerous game of chicken, with the oil market, and within its own hallowed halls of power and internal intrigue.

Nigeria and Venezuela announced production cuts recently, and OPEC generally provided moral support to the new members. Yet, oil prices have retreated since the announcement, suggesting that the market does not believe that OPEC can hold to its promise of production cuts at this time.

The key is the fact that Saudi Arabia, although rumored to have cut back production "quietly," has not made any official announcements.

Furthermore, OPEC's history of cheating on production quotas is hampering any shock in prices at the moment.

Putting Cuts In Perspective

Statistically speaking, if Nigeria and Venezuela cut back production, it is little more than a token move.

According to Bloomberg: "Venezuela and Nigeria will lower crude oil production by a combined 170,000 barrels a day, the Organization of Petroleum Exporting Countries said on Sept. 29. Both countries produced less than their OPEC quotas in August."

More interesting is the fact that production numbers from Venezuela and Nigeria are suspect in the first place as "Venezuela produced 2.5 million barrels a day of crude oil in August, less than its quota of 3.2 million, according to Bloomberg estimates. Nigeria produced 2.2 million barrels a day in August, less than its OPEC target of 2.3 million, according to the estimates."

All Talk?

According to Stratfor.com: "Venezuela and Nigeria are the least reliable and stable of the 11-member OPEC group and - the two countries have no real intention of making the cuts in the first place."

Stratfor notes that "Lower prices could hit both Nigeria and Venezuela hard -- not only economically, but politically as well."

Nigeria has significant problems since "Attacks on its infrastructure are already affecting Nigeria's output."

Lower oil prices could affect the country's already troubled social structure as "Nigeria counts on oil revenues to help sustain its great bribe continuum, which in turn keeps the many violent and troublesome parties -- rival private security forces, political and tribal militias and criminal gangs -- under some sort of control."

Venezuela has its own set of issues as "Venezuelan President Hugo Chavez has his own reasons to keep oil revenues high. Though Venezuela is tapped into the world's largest energy market -- roughly 11 percent of the United States' oil imports come from Venezuela -- Chavez has tripled government spending within just three years and needs money to keep coming in from somewhere."

According to Stratfor, lower oil prices could force Chavez to make some difficult choices: "This is not to say that low oil prices will crush Chavez; he has a currency reserve account pushing $35 billion. However, Chavez counts on that money before it is even fully in his bank account to pay for loyalty. If prices continue to slide, Chavez will have to think hard about which among the 100,000 gun-toting loyalists, the subsidized rural population in the millions, or the fellow left-leaning Latin American countries he wants to cut out of his budget."

Conclusion

The key is to watch the Saudis.

Stratfor puts it quite succinctly: "Saudi Arabia will not easily be spooked into cutting its production, not only because of its close ties with the United States but also simply because market movements -- any market movements -- affect the Saudis' bottom line more than anyone else's. Saudi Arabia will closely and cautiously watch U.S. inventories in order to make a decision."

In other words: "With U.S. inventories brimming and U.S. demand down after the end of the summer travel season, Saudi Arabia could very well cut production, but it seems pretty comfortable with oil prices hovering in the $60 area. If oil trends towards the $40 mark, then OPEC as a whole will move without delay to change its quotas and production -- but that would be too late for countries like Nigeria and Venezuela."

That means that the U.S. economy, and by default, the Chinese economy are now the keys to the situation. Further slowing in the U.S., will eventually translate into some kind of slowing in China

If that dynamic extends far enough, and lasts long enough to significantly affect demand, ramifications will start to cascade along the food chain, and dare we say it, the slippery slope will likely get very greasy.

© 2006 Joe Duarte, M.D.
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