Saturday, November 01, 2008

OPEC: A TOOTHLESS DOG...



Crude oil prices exponentially increased from $US 20/barrel in 2001/2002 to over
$US 140/barrel in July 2008 - due not to a shortage in supply but to both massive speculative buying of crude futures on the commodities futures markets and to the free fall of the $ US exchange rate (+ 30% from 2001-2008), and than crashed by more than 50% in less than 3 months, from over + $US 140/barrel in July 2008 to less than $US 60/barrel by the end of October 2008, despite OPEC's decision in October to reduce output by 1.5 million barrels per day.

According to OPEC's latest monthly report:

"The Basket reached a twelve-month low of $72/b on 13 October, representing a decline of almost $69/b in little more than three months." Crude oil prices reflect the dramatically worsening conditions in global financial markets in recent weeks and their negative impact on the real economy, as well as the decline in the demand for oil. All these events are expected to impact different aspects of the oil market, including demand for crude and products, particularly in OECD countries and to a lesser extent in emerging market economies."

Source: www.opec.org (OPEC monthly report October 2008)

However, although the "dramatically worsening conditions in global financial markets in recent weeks and their negative impact on the real economy, as well as the decline in the demand for oil" certainly play a large role in the "dramatic collapse, unprecedented in speed and magnitude” of crude oil prices over the last 3 months, the global financial crisis and market fundamentals of supply and demand alone cannot explain or justify such extreme price decline and volatility.

The first lesson that clearly emerges from this crisis is that OPEC – despite the fact that the cartel accounts for 40% of global oil production – does not in reality have much control over prices of crude oil on the world market.

This is due to the fact that OPEC only controls one of the variables that determines and sets the price of crude oil on the world market – namely control over its production policies and crude oil output. However, supply-management by itself is not sufficient to control or set prices on the world market, as the current situation clearly reveals.

There are other equally crucial exogenous factors – over which OPEC has no control - which play a major role in setting prices of crude oil – or of any other traded commodity - on the world market, such as:

1) Speculative trading of crude oil on the commodities futures markets

2) The exchange rate of the US dollar ( price of crude oil inversely related to the value of the $)

3) Production policies and output of crude oil by non-OPEC members who collectively produce 60% of the global oil output.

4) Geopolitical situation in oil producing countries

Failure of OPEC to take into account and address these crucial exogenous factors which directly influence both the volatility and price of crude oil can only result in the failure of OPEC to control and set prices of crude oil on the world market.