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Singing the OPEC blues
Posted by: McQ on Friday, October 20, 2006

Yes friends, that cut of one million barrels a day that OPEC wants to impose to keep the price of oil high? Well, it's having a rough time:
Analysts doubt that the Organization of Petroleum Exporting Countries will cut output by as much as it said it would this week at a Qatar meeting.

OPEC, which supplies about 40 percent of the world`s crude oil, said it would trim its output, beginning Nov. 1, 1.2 million barrels per day to 26.3 million barrels per day, an approximate 4 percent reduction of the cartel`s current nominal production quota.

'If the organization reverts to type and overproduces, prices will continue falling through the fourth quarter and into the first,' Simon Wardell, an oil analyst with Global Insight, said Friday in a news release.

'What should be expected is something of a compromise, an actual cut of approximately 800,000 barrels per day. This will help to solidify prices, but given current inventory levels the draw-down will be slow. The wild card is how severe the northern hemisphere winter is. A mild winter will put more pressure on OPEC to cut again when they meet in December.'
It is one thing to cut production when its at $20 bucks a barrel. Obviously the incentive is there to push the price higher. But when you're at $60 a barrel, the incentive to cheat is even higher. I'm no oil expert so I have no idea if an actual cut of 800,000 barrels a day is actually achievable, but I do know the incentive to reach those numbers may not be as powerful as OPEC believes (especially if non-OPEC suppliers kick it up a notch).
 
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Nobody will be happier about this than Russia. If OPEC manages to cut production and raise the price Russia can pump more oil volume at a higher price and make a lot of money.

As anybody familiar with classical economics (not that Keynsian crap) they would know that voluntary cartels do not work and are not to be feared. OPEC has never had the kind of power that has been attributed to it. The oil shocks and price increases of the 1970’s were really caused by a decade of loose monetary policy not OPEC’s clout. When the loose money went away in teh early 80’s the price came down despite every effort of OPEC. If OPEC really had the power people think it does we would never have had $10 oil in the late 90’s, that’s for sure.

Oil is a commodity and it has moved consistently with most of the other global commodities based on the amount of currency floating around the globe. If the excess currency is mopped up, as it appears has started, the price of all commodities will come down. Watch gold, copper, iron, the dollar, etc.,etc.,etc they all move together with oil because their prices are driven by the same thing: central bank money creation (or lack thereof).

What is a sad is that the demand side economics that has been taught to every business person and undergraduate over the last 50 years will continually find the wrong answers to this phenomenon, and will probably attribute the falling oil price to a reduction in GDP in the US (regardless of what happens elsewhere) and attribute falling inflation to reduction in US GDP. Of course this standard line of thinking completely misses the cause and effect relationship at work here. Unfortunately it appears that the biggest users of this theory are the Fed governors who have caused this to happen in the first place. When you see what theories they are laboring under it shouldn’t be any surprise. As Milton Friedman said: "central banking is too important to be trusted to central bankers".
 
Written By: DS
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