Over 220 years ago, a Scottish writer by the name of Thomas Carlyle provided a personal account of what Paris was like during the French Revolution. The three-volume work (which at one point I suggested in an academic article was two volumes longer than necessary) is full of personal anecdotes. One of them is particularly relevant these days.
On a hot afternoon, Carlyle was sitting in a coffeehouse with a supposed high fellow of the revolution. Suddenly a shouting crowd with raised pitchforks rushed by. The revolutionary jumped to his feet, apologized to Carlyle, and said: “Those are my people. I am their leader. I must follow them.”
Cut to yesterday.
The last two trading sessions have prompted a frantic rush among investors to find whatever safe haven from a global market implosion may be available. Yet, in my circles, there is an even more interesting development afoot, one that brings back Carlyle’s 1790 conversation.
Here’s what’s really going on in the oil markets right now…
OPEC’s Backfiring Plan
What had begun as a calculated move by OPEC producers to protect market share has morphed into a crushing decline in crude oil prices. The downward spiral in the oil market now has a life of its own. And in the process, its creators are panting to catch up.
Like a snowball racing down the mountain, those who set it in motion no longer control where it is heading.
Beginning last November (on Thanksgiving, no less) OPEC started the policy assault by deciding to keep production constant. By doing so, it telegraphed an intention to protect its international market share rather than the price.
What followed was the first of two significant pricing slides.
In the process, it became clear that not all cartel members were in the same boat. While all members were experiencing shortfalls in revenue – requiring deficit financing for central budgets – only Saudi Arabia, Kuwait, and the United Arab Emirates (UAE) could afford to carry the policy along without serious financial problems.
Other OPEC members, such as Venezuela, Libya, Algeria, Nigeria, Iran, and even Ecuador (the smallest producer and exporter in the group), require triple-digit crude prices to have any hope of balancing already suspect budgetary outlooks.
The Saudis Target Russia and the U.S.
That translated into a rising desperation among the also-rans to produce and export well above their monthly quotas. The receipt shortage was demanding that they sell additional amounts of oil into an already oversupplied market. That drove prices down further.
No longer able to control the situation, the Saudis decided to continue appearances as the “leader” of OPEC and increase their own production and sales. That way, the overproduction could be portrayed as a cartel-wide decision. Of course, prices went down in consequence.
There were two targets for these machinations. The first is the Russians. Moscow has a completed ESPO (Eastern Siberia-Pacific Ocean) pipeline with a crude oil grade better than Saudi exports destined for the Asian market.
The Saudis needed to offset that competition in what is becoming the principal worldwide energy market. By cutting prices significantly, Riyadh is requiring that Moscow move oil to Asia at a loss. Recent strong statements from state giant Gazprom that the trade will continue despite Saudi moves are actually a recognition that the OPEC policy is working in limiting Russian exports to the energy-thirsty region.
The second target is the one getting all the media attention. U.S. shale and tight oil production had been accelerating, with the traditional “call on OPEC” being replaced by the “call on shale” in setting prices.
Now the American impact remains indirect, since the vast bulk of domestic production cannot legally be exported. Yet OPEC knows that more than 80% of the world’s extractable shale and tight oil is not located in North America.
That means the contest with the American oil patch is the “test case” for a problem they will be increasingly facing as other countries turn to developing local unconventional volume.
The Chinese Stock Market Implosion Changes the Game
And then the other shoe fell. Two of them, actually, and both Chinese.
First, Beijing began importing more African oil, especially from other OPEC members Angola and Nigeria. The prospect has required Saudi Arabia to lower its own export prices and to enter into an intra-OPEC competition.
Left in the wake as well is Iran, which has relied on China as its primary trading partner throughout the period of Western sanctions.
Normally, lowering prices to one region would result in raising export prices to others, especially in this already reduced pricing environment. But then the second shoe fell.
The Chinese stock market implosion hit. Not only has this introduced concerns (largely overblown, in my estimation) of an impending major decline in Chinese energy needs. The market collapses in Shanghai and Sichuan have ushered in a global market meltdown.
This dual whammy from the Orient has slashed crude oil prices well below where OPEC wanted them. The policy they had introduced to maintain their market share in the face of competitors is now under the direction of forces beyond their control.
As I write this, it is 1 a.m. U.S. Eastern Time. Shanghai is down another 4%. OPEC will need to reassess its strategy shortly.
Carlyle must be smiling in his grave. Déjà vu is like that.
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