Stock World Weekly: Politics Of Oil And Price Wars

In the latest Stock World Weekly, we discuss oil prices, OPEC, econo-politics and more; and Phil provides several trade ideas including one with USO. (Read the newsletter by clicking here and trying PSW free.)

Excerpt:

Reasons for the continuous drop in oil prices are clear: booming US production, declining demand in many regions including Japan, China and Europe, and strides in vehicle fuel efficiency. Fracking (hydraulic fracturing) and horizontal drilling techniques have enabled oil production from hard shale rocks in states such as Texas and North Dakota and have contributed to the US's move towards top world-producer status. 

Results: The price of Brent has fallen over a third since June of this year.

Given the declining oil prices, it was perhaps surprising when representatives of the Organization of Petroleum Exporting Countries (OPEC) decided to keep oil production unchanged last Thursday (Thanksgiving). Many analysts expected OPEC to cut supplies to help boost prices. The announcement sent West Texas Intermediate (WTI) crude down to $66.15 per barrel and Brent crude down to $70.15 per barrel. As oil and oil stocks sold off, airliners celebrated with their stocks hitting record highs because oil is one of their largest expenses. 

Clifford Krauss at the NY Times explains the surprising move--or non-move--by OPEC:

That elusive goal [of American presidents since the crippling oil  embargo of 1973] may finally have arrived, at least for the foreseeable future, with the failure of Saudi Arabia and its 11 oil cartel partners in the Organization of the Petroleum Exporting Countries to agree to a production cut that would put a brake on plummeting crude prices.

[...]

The inability or unwillingness of OPEC to act showed that the cartel was no longer the dominating producer whose decisions determine global supplies and prices. Suddenly, the United States — which is poised to surpass Saudi Arabia as the world’s top producer, possibly in a matter of months — is in that position, although the resiliency of that new command must still be tested. 

“This is a historic turning point,” said Daniel Yergin, the energy historian. “The defining force now in world oil today is the growth of U.S. production. The outcome of the OPEC meeting is a clear indication that the oil exporters now recognize that this is a new market.” (Free Fall in Oil Price Underscores Shift Away From OPEC)

The drop in US oil prices has been good for the US consumer and analysts are expecting a profitable holiday season as Americans have more money to shop. The National Retail Federation is forecasting holiday sales this year to be $616.9bn, 4.1% above last year’s sales. Online sales are predicted to grow from 8% to 11% as railers are working to create more user-friendly online shopping experiences. 

But OPEC, the oil cartel responsible for about 30% of worldwide oil production, probably didn't choose to let oil prices fall further simply to see Americans spending more on useless crap for Christmas. 

For David Goldwyn, the State Department’s coordinator for international energy affairs in the first Obama administration, OPEC’s decision not to cut was “strategic.”

“What we have now is a yearlong game of chicken,” he said. “The Saudis are waiting to see how much U.S. production adjusts because of prices and they are waiting to see how much pain the other major oil producers can take before they are willing to make meaningful cuts.” Referring to the global oil benchmark, he added, “If Brent sinks below $60, I think you will see OPEC hit the panic button pretty fast.” That would mean an extraordinary OPEC meeting, and emergency cuts in production.

[...]

For OPEC producers like Venezuela and Iran, the tumbling price in oil has produced economic hardship and potential political problems.

Venezuela and Algeria contend that OPEC needed to band to together to cut production and raise prices. But Saudi Arabia has by far the most sway in OPEC, since the kingdom produces roughly one-third of OPEC output alone. It also has the financial muscle and spare capacity to lower or raise production whenever the Saudi royal family deems necessary.

The drop in oil prices has been most difficult for OPEC producers such as Venezuela and Iran. Venezuela and Algeria wanted to cut production to raise prices, but Saudi Arabia disagreed. Because Saudi Arabia produces about 33% of OPEC's output, it has the "most sway," plus the financial wherewithal and spare capacity to adjust production when it sees fit. 

In this "game of chicken," Krauss continues, there is no guarantee that the United States will permanently hold onto its powerful edge. The Saudis hope that lower prices will decrease production using the more expensive practices, drive high-debt companies out of business, and cause other companies to limit their exploration plans and reduce production. (Free Fall in Oil Price )

Along these lines, Brad Plumer of Vox.com argues that OPEC is starting a price war with the US: 

This marks a big shift in global oil politics. Essentially, OPEC is now engaged in a price war with oil producers in the United States. The cartel will let prices keep falling in the hopes that many of the newest drilling projects in the US will prove unprofitable and shut down.

This is a risky stand-off for OPEC, as many of its member countries require high oil prices to balance their budgets. Iran, for one, is facing a real pinch. It’s also a sign that OPEC’s influence over global oil markets may be waning. (Oil prices keep plummeting as OPEC starts a price war with the US)

Barbara Kollmeyer, editor for MarketWatch, suggests that OPEC, in effect, has done what the Fed has failed to do: started another QE program. Let's call it "QE4":

As if on cue, OPEC stepped in just as monetary policy (at least the Fed’s) has dried up. Central bankers have nothing on the oil cartel that did just what everyone expected, but has still managed to crush oil prices.

Protest away about the 1% getting richer and how prior QE hasn’t trickled down to those who really need it, but an oil cartel is coming to the rescue of America and others in the world right now.

It’s hard to imagine a “more wide-reaching and effective stimulus measure than to lower the cost of gas at the pump for everyone globally,” says Alpari U.K.’s Joshua Mahoney. “For this reason, we are effectively entering the era of QE4, with motorists able to allocate more of their money towards luxury items, while firms are now able to lower costs of production thus impacting the bottom line and raising profits.”

The impact of that could be “bigger than anything that has come before,” says Mahoney, who expects that theory to be tested and proved, via sales on Black Friday and the holiday season overall. In short, a consumer-spending explosion as we race to the malls on a full tank of cheap gas. (OPEC has ushered in QE4, and how investors should play oil now)