Risk has been off for almost a week now – oil, equities, sterling, you name it, all have been under pressure in the past few days and investors stampeded towards the exit in growing numbers yesterday. The dollar, gold and bonds, on the other hand, welcomed the money that deserted other asset classes with open arms.
The change in the mood is the combination of several factors. Firstly, flare ups in coronavirus cases are causing growing unease. There have been well over 27 million registered cases and the death toll approaches 900,000. Regional lockdowns are being re-introduced. The virus has not been contained and consequently the stock market rally of the past six months is proving to be unjustified. The latest quarterly growth figures -Japan, the EU, South Africa- reflect anything but hope. The Nasdaq index fell over 4% yesterday. Talks of no-deal Brexit are getting louder once again as the UK government is set to ignore part of the divorce agreement with the EU that is related to Northern Ireland – or intends to break international law, to put it bluntly. The US plan to put the biggest Chinese chipmaker on blacklist has only added spice to the bearish cocktail.
After the fall in Chinese crude oil imports and the Saudi cut in next month’s OSP oil was not immune from developments in the financial markets. If stocks are in free fall worries about tepid oil demand growth will only escalate. The EIA will provide us with some guidance this afternoon when it releases its monthly supply-demand report but currently the odds are firmly stacked against bulls. Oil prices will fall nowhere near to the lows in April, the ongoing correction could prove sharp but short-lived and the global oil balance is still expected to tighten meaningfully next year. Nevertheless, investors are currently on the defensive as the summer trading range has been broken out of on the downside.
Happy 60th Birthday OPEC! No plan to retire.
The coronavirus crisis has upended numerous plans and threw the whole world into chaos. It has even led to the postponement of OPEC’s anniversary celebration planned for tomorrow in Iraq. It will be sixty years tomorrow that the Baghdad conference took place. It led to the creation of OPEC four days later, an intergovernmental organization with five founding members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. The organization’s declared objective has always been to co-ordinate the energy policies of member countries in order to provide fair prices both for producers and consumers. Its updated Statute states that the “organization shall devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations”. Any country who is a net exporter of crude oil can apply for membership subject to acceptance by 75% of member countries.
OPEC has come a long a way over the past six decades and has grown into the single most important organization with huge influence on the oil balance and prices. It has turned into a global swing producer, the central bank of the oil industry. Its membership has evolved according to the interest of individual countries and currently there are 13 members within the organization spreading through three continents. Although its main objective, as outlined above, is to provide stability it is a political organization. It did not, back in the past, shy away from using oil as a weapon. In October 1973 OPEC introduced an oil embargo against countries (Canada, Japan, the Netherlands, the UK, and the US) that supported Israel during the Yom Kippur war. Oil prices quadrupled from $3/bbl to $12/bbl in the space of six months.
Oil prices strengthened through that decade and member countries launched massive economic and social development programmes. The 1980s were characterized by two major events that had a profound impact on the organization. Consumer nations, keen to reduce dependence on OPEC sought alternatives in the form natural gas and nuclear power and at the same time encouraged exploration and production. Oil fields in the North Sea and Mexico started production in direct competition with OPEC. In its attempt to protect prices OPEC reduced production but this only led to falling revenues. This strategy was later in the decade altered and the quota system was introduced. In the meantime, the 1980-1988 Iraq-Iran war threatened the existence of the organization, but it survived.
At the beginning of the next decade Gulf War I broke out causing a price spike leading to an increase in output. At the end of the 1990s oil prices plummeted below $10/bbl due to the South-East Asian economic crisis and the unusually mild winter in the Northern Hemisphere. Once again, the quota system proved to be a useful tool in balancing the market in both extremities.
In the new millennium not even improving co-operation between OPEC and non-OPEC producers was able to halt the rally close to $150/bbl triggered by the seemingly insatiable Chinese appetite for the black stuff and by the increasing role of speculators due to technological advances. After the recession that followed this peak, prices started to stabilize in the $80-$110 band despite social upheavals in North Africa. OPEC, once again, played a great part in it. However, the next challenge emerged soon – US shale. The ill-fated attempt by the former Saudi energy minister, Ali Al-Naimi, to destroy the US shale industry by opening the oil spigots ended in failure and OPEC was forced to look for an ally. It did what was logical to do under the circumstances – to increase its control of the global production by striking a supply deal with Russia and nine other non-OPEC producers.
History will judge whether the OPEC+ alliance was meant to be a brief marriage of convenience or the two producer groups had a long-term vision in 2016. The fact of the matter is that OPEC, which, in the past thirty years, controlled anywhere between 35% and 45% of the world’s production managed to keep and even increase this share by forming the unprecedented alliance with non-OPEC producers. Without this pact the ongoing demand destruction caused by the pandemic would not have been managed as well as it is. When global consumption and production picks up again the inevitable question will be asked: do efforts to reduce the use of fossil fuel justify the existence of the central bank of the oil market or has it accomplished its mission? The answer is simple and ambiguous at the same time. As long as oil remains a crucial element of the energy mix OPEC will always have an important role to play.