More news on the future of the world’s most important commodity again over the weekend. Oil prices slumped after another Opec meeting in which divisions within the cartel were obvious.
There’s a strange symmetry developing between central bank policy and the way Opec is acting. Central banks talk of “forward guidance” to set expectations in the market. In simple terms this means if the Bank of England wants the pound to go up it’ll start talking about an interest rate rise, hoping that talk alone will do the trick. If it works, the markets do what the bank wants without it ever having to raise interest rates.
Now look at what’s happening with Opec. What Opec wants is stability for the oil price. It may even want prices to tick higher (more on that in a second). To do this it knows a cut in production is probably required. But failing that, talk of a future cut – forward guidance – will suffice.
Going into the latest Opec meeting over the weekend, that seemed to be the most likely outcome. Not a cut. But more talk of one. Some guidance for the market to digest.
It didn’t work like that
A cartel only works if the whole is greater than the sum of the parts. There has to be unity. The individual goals and ambitions of each individual nation have to mirror the goals of the whole group, otherwise you get chaos.
We’re not quite at chaos yet, but we’re getting there. Opec is only as strong as it is united, and right now it’s divided. Before the weekend, the plan Opec had been indicating to the market was for a production cut in November. This meeting was a precursor to that and a chance to talk the plan up.
The problem is, it became clear over the weekend that more and more nations are now seeking an exemption from the cut. The more nations do that the more pointless the cut itself is. And there’s always the underlying threat that if Opec as a whole cuts production, an individual nation could go rogue and increase it to gain market share.
In short, national interests are trumping the interests of the wider organisation. Why is that?
Keep in mind that Opec is not a central bank – it can’t just “set” the price of oil the way a central bank can just decide what the price of money (the interest rate) should be. It can’t know exactly what will happen if it cuts production.
That introduces an element of risk
Imagine you’re an oil producing nation and 40% of your national revenue comes from oil. You’ve just suffered a major bear market and your national finances are in a mess. What happens if you cut production… only for the price to stay the same? You lose money. You’re selling less oil at the same price as before. The price climb has to make up for the loss of volume. If it doesn’t, you’re in trouble.
That introduces risk to the equation. It makes you think twice before agreeing to cut along with other Opec nations. And that fundamentally weakens Opec’s position.
And remember this: Opec is looking for the “perfect” oil price for itself and its members. Not too high and not too low. The Goldilocks price. If prices fall too far, its own members will suffer again. If prices spike, that helps its rivals – mostly shale and other tight oil producers in the US.
Narrow margin for error and discord within the group. What could go wrong?
Who knows. But going into the weekend, US Commodity Futures Trading Commission data showed that short positions against oil futures are at their highest level since 2007.
We’ll come back to this as the week goes on.
That’s all for now,
Nick O’Connor
Associate Publisher, Capital & Conflict
Category: Geopolitics