OPEC Will Drive Down Oil Prices

The operating theory of most oil analysts and economists is that OPEC will let prices go up and up. Nothing could be further from the truth.  Goldman Sachs has said oil could spike to $200 a barrel sometime in the next two years, but that won’t happen.

Oil is now at $120 and on its way up. The kings and princes in Saudi Arabia and Dubai are adding to their wealth at the rate of tens of billions of dollars a year. Their plan has been to hold demand and accuse speculators and the dollar of pushing up prices. They don’t want to discuss demand increasing in China and the emerging markets and slower production from big exporters like Russia, Mexico, and Venezuela.

The ministers of OPEC are greedy, as they should be, but that are not boobs or buffoons. The know that there is a tipping point when oil prices will move inflation from the category of concern to the column of disaster. They know what inflation can do. They help create the last big wave in 1973. That also increased unemployment to over 8% in the US and worse in other developed countries.

A real global recession is no better for OPEC than it is anyone else. The cartel wants fairly even consumption. Spikes up and down are not suited for a systems with fixed production, shipping, and refinery operations. The current infrastructure is not set up for big swings in oil use.

So far, the economy has favored OPEC. No major country has fallen into deep recession. Inflation is more a concern in China and India than in the US, but their GDPs are growing faster meaning that they can more easily absorb the costs, at least for now. An idle oil infrastructure is expensive to maintain.

The tipping point. It may not come at $120, but somewhere North of that, gas moves to $5 very quickly, It was $3 late last year. That affects China as much as the US. The central government in the world’s most populated country can underwrite bringing in $100 oil and pushing it out of refineries at sub-market prices for oil and diesel. It keeps China’s transportation network moving. It feeds the 10% GDP growth driven by exports. But, what happens when other economies slow and exports are harder to come by? That also makes it harder for the Chinese government to come by the money to process oil on the cheap.

In the US, inflation is already robbing the general population of capital it needs for basics. Gas plus mortgage costs have eroded consumer spending. If unemployment moves up, the cart falls over and a recession could become deep and long.

OPEC’s machinery gets broken if oil demand takes a sharp plunge. If oil prices move up another 10% to 15%, the odds of that happening go higher geometrically

Douglas A. McIntyre