Wednesday, December 30, 2015

Is OPEC Still Relevant in an Oversupplied, Low Price Oil Market?

  • The world oil market is estimated to be over-supplied by 1.5M BBL/d, yet Saudi Arabia and OPEC continue to maintain higher rates of production.
  • Prices of oil have plummeted since mid 2014 from highs above $100 per barrel to recent lows below $35 per barrel in December 2015.
  • This article reviews the oil supply and pricing dynamics since the Arab Oil Embargo, including 5 other points in time over the past 40 years when oil prices went up or down dramatically.
  • The data reveal that if you inflation adjust prices back to a time pre-Embargo, using 2015 prices, $50 per barrel is currently the point that prices are likely to stay below until over-supply clears.
  • Additionally, market price and supply levels post 1986 provide valuable investor insight into the geopolitical landscape changes required to change the current market trajectory.

Market discussion was heated after the December 4, 2015 OPEC meeting about whether the organization was “losing its relevance”.  The argument was that since the price of oil continued to free fall after the meeting because the Saudi led cartel did not scale back production to support the price, that somehow the organization had lost its grip on the world oil market.  The inability of the group to agree on an official quota left organization members producing at a rate of 31.5M BBLs a day.  The result of the meeting was not received well by the market.  Subsequent to the meeting the prices of crude dropped below $35 per barrel for WTI and $40 per barrel for Brent and show little sign of quickly rebounding.

To understand the relevance of OPEC today, I believe you need to review the history of points in time that the price of oil moved significantly, both up and down.  And, since oil is priced in U.S. dollars, the prices need to be normalized for U.S. inflation through time so that changes in the supply of oil relative to demand can be better understood.  With this framework in mind, I went back to the point in history when OPEC was arguably at the peak of its power as an organization, the Arab Oil Embargo, and examined 5 major price discontinuity points since that time.  The results of the research are shared in this article I recently published on Seeking Alpha.

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