It looks as if Opec is determined to mess up the world economy and its own prospects for preserving...
It looks as if Opec is determined to mess up the world economy and its own prospects for preserving the hefty increases in its oil revenue. After spending much of last year pumping more oil when prices were surging, the Organisation of Petroleum Exporting Countries (Opec) now appears determined to cut production for the second time this year in a bid to keep prices above $25 a barrel.
The timing couldn't be worse. Economic growth already is slowing. Cutting oil supplies and boosting prices may send the world into recession, reducing the growth in energy consumption. Yet the 11-nation group appears to be intoxicated by high prices and determined to avoid the glut that sent oil crashing to $10 a barrel in 1998. Oil fetches about $28 in New York now, almost double what it was two years ago, when $15 was considered a good price by producers.
The oil minister for Saudi Arabia, the largest producer, said last week that Opec would agree when it met to cut production, and that the group wants to keep its price benchmark, a group of seven types of crude oil, about $25 a barrel. The price has fallen by 8% in the past month to $24.38, and Opec is concerned that demand growth will slow in the months ahead.
Ministers seem to think that higher oil prices aren't contributing to the economic slowdown. "Economies go up and down," Obeid bin Saif Al-Nasseri, oil minister for the United Arab Emirates, said recently. "I don't think oil is responsible."
History suggests Al-Nasseri is wrong. Over the past 30 years, there have been four periods when oil prices surged, including the most recent one. In each of the previous three, the rally in energy prices put the squeeze on the economy.
Oil prices more than tripled in the first and second oil-price shocks in the mid- and late- 1970s. Both lasted for about five years and sent the US economy into recession. In 1990/91, during the Gulf War, prices doubled. While that rally lasted just six months, it still triggered a recession in the US.
This time around, prices have doubled from early 1999 to 2000 and have maintained this gain for more than a year.
What makes the current situation so precarious is that this is the first time in 25 years that the world's three largest economies, the US, Japan and Germany, are in a synchronised economic slowdown. In 1980, the Germany and US were in recession but Japan was not. In 1990 only the US economy was in recession. Higher oil prices now will turn global slowdown into global recession.
During the quarter ended 31 December, the US economy expanded at a meagre 1.1% annualised pace, and the Federal Reserve cut interest rates twice in January to reverse the slowdown. Germany's economy grew at just a 0.2% pace. While Japan reported fourth quarter growth of 0.8%,the yen fell to a 20-month low against the dollar last week on signs that what little growth there was has disappeared this year.
Opec is ignoring these economic signals less than a year after taking actions that showed it was concerned high prices would hurt the economy.
Last year, as prices surged to more than $37, Opec boosted daily production levels four times to slow the rally.
It even introduced a price band of $22-$28 per barrel, saying it would defend oil by pumping more or less to keep prices in that range, not unlike a central bank might with its currency.
Since then, Opec members have said $25 is the lowest they want prices to be.
By doing that, the group is effectively saying it will keep cutting supply to keep a floor under the price of oil.
That's great news for oil companies, who say $17 to $18 is their breakeven price for oil exploration and production, so there's plenty of incentive to find and produce more oil.
If Opec goes ahead with plans to cut production, it will retard economic growth at the same time its helps stimulate oil production outside its control. Both developments erode demand.
Brendan Moynihan via the Bloomberg Chicago newsroom
All-day event on 24 April
Consequences could be more severe than in stress tests
AFH has six segregated mandate funds
Variable operating expenses