a cartel is a dangerous thing

The Oct NYMEX crude oil contract closed at $103.26, near the low of $101.74, which is close enough to the psychologically significant round number $100 to be really interesting. Even better, the price didn’t move much after OPEC decided to cut output a little, only to $103.48 by 6:13 am ET today, over a half hour since the OPEC story came out. OPEC will cut production by around 520,000 barrels per day for the next 40 days, or about 1% of supply and putting production back where it was during the first quarter, according to the WSJ.

What the WSJ fails to report is that when Indonesia resigned from OPEC, having become a net oil importer, OPEC lost “control” of its production of 865,000 barrels per day, so a cut has to be expected in the first place. Also, OPEC had been producing 520,000 above quota in July, according to OPEC president Khelil, as the “cut” of 520,000 is actually a confirmation of the existing quotas (in place since Sept 2007). In short, it’s not really a cut. Oil prices initially rallied on the production cut announcement (to $104.82) but then the the market got smart and realized OPEC had done as expected, affirmed existing quotas.

In addition, the International Energy Agency again cut its forecast for global oil demand in 2008 by 100,000 barrels and in 2009 by 140,000 barrels, due to global slowdown and changing consumer behavior. This pretty much leaves us where we were before, and with speculative demand deeply on the wane, the impetus for higher prices is defused.

Bloomberg reports that according to critic Masters, who runs a hedge fund and lambasted index managers in Congressional testimony in July, now says commodity index investors sold $39 billion worth of crude oil futures between the July record high price and Sept. 2. This is what is behind the drop in the price of oil.

His report will presumably be available to one and all today, thank goodness. His timing is terrific, since the CFTC has to present its own report to Congress tomorrow. The CFTC claims Masters doesn’t have the data he needs to make his case, but Congress has found him credible. Bloomberg says “He has been cited by lawmakers who introduced at least 20 measures to curb speculation.”

Masters says that Congressional pressure on the CFTC to step up enforcement and restrict anonymous trades has pushed index traders out of their positions. “I don't think it's just coincidence that the money came out after the pressure was put on these folks.''

Who are these people? It’s JPMorgan Chase, Goldman Sachs, Barclays and Morgan Stanley, who together control 70% of the commodities swaps positions, and swaps dealers are the largest holders of Nymex crude oil futures contracts, according to Masters. “These large financial players have become the primary source of the recent dramatic and damaging price volatility,'' Masters said in the report. The banks decline comment but realistically, they have to be in the grip of the lawyers and public relations folks at this point. We are inclined to think Masters is right and even if he isn’t, Congress thinks he is right. Speculators are certainly pulling back as we see from the price. Masters thinks it could be $65-70 in their absence.

And it is clear that the propensity to panic and shove prices higher on the slightest excuse seems to have fled entirely, or to have been overwhelmed by other considerations. Russia proposed to OPEC an "extensive cooperation" understanding that normally would have fallen like a bomb on the oil futures market. According to the WSJ, Russia says “the memorandum of understanding could take two months to sign, suggesting it could be finalized in October when OPEC representatives come to an international oil conference in Russia.” This is a high-stakes game.

Russia would not have disclosed the existence of a possible deal if OPEC had not already indicated it will get done… and yet what’s in it for OPEC in general and Saudi Arabia in particular to make pals with the “enemy” of its best customers? We put “enemy” in quote marks because it’s a strong word—maybe “adversary” is a better one.

The FT is much calmer about it, saying Russia is an “observer member” that doesn’t share in the voting or quota system. “The last time Russia cut its output in solidarity with Opec was in 1999, when Mexico and Norway also reduced their production to help boost prices that had fallen to 9 dollars a barrel.” So-called “closer cooperation” between Russia (11% of world output) and OPEC (40% of world output) is not cause for alarm, with OPEC having “recently held a relatively benign position and become a reliable supplier of oil to the world for more than two decades.”

But wait a minute—a cartel is a dangerous thing. OPEC has been a weak cartel, unwilling or unable to enforce quotas that many producers openly flouted. Any change that makes OPEC stronger as a cartel has to be a bigger risk to the consuming countries, not to mention the diplomatic aspects. The US is already concerned on Europe’s behalf that Russia can and does dominate the oil supply scene there. This is not ithe US interfering in other people’s business but rather a realastic assessment of potential future costs to the US. After all, to whom will Europe turn if Russia closes the spigot?

Bye For Now

Barbara Rockefeller