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October 22, 2014

Crude Oil: When Price Makes the Story

By Kurt Cobb 
So oft in theologic wars,
The disputants, I ween,
Rail on in utter ignorance
Of what each other mean,
And prate about an Elephant
Not one of them has seen!
--The Blind Men and The Elephant by John Godfrey Saxe
When the world's business editors sent their reporters canvassing to find out what is behind the recent plunge in the world oil price, they were doing what they do almost every day for every type of market: stocks, bonds, currencies, commodities and real estate.

In financial journalism more often it's the price that makes the story rather than the story that makes the price. If a story is about something very surprising which almost no one can know in advance--a real scoop--say, an unexpected outcome in a major court case affecting a company's most profitable patent, then the story will move the price of the company's stock.

But much more often prices move, and then business editors send their reporters to find out why. Usually, a number of financial and industry professionals are asked: Why do you think prices went up/down? Then, the story is written and published.

However, on a daily basis, unless there is a big and obvious story like the one above, the only true answers are these:
There were more buyers than sellers. (UP)
There were more sellers than buyers. (DOWN)
These answers, of course, aren't really news. They are more like axioms.

The answers for the recent swoon in the oil price include:

  1. Oil is purchased in dollars and the dollar has been rising which puts downward pressure on the oil price.


  2. Demand is declining in Asia and Europe which is leaving excess oil on the market driving down the price.


  3. Growing production from the United States is adding to world oil supplies and bringing the price down.


  4. Libyan production has rebounded sharply following the country's recent period of unrest.


  5. Saudi Arabia, the only OPEC producer with significant additional production capacity, is pumping more oil to punish other OPEC members with a low price, a move designed to restore discipline among members so that they will abide by future oil production quotas.


  6. Saudi Arabia is pumping more oil to bring the price down to aid the United States in its diplomatic objectives, pressuring Russia, the world largest oil producer.


  7. Saudi Arabia isn't trying to help the United States; the kingdom is actually trying to hurt the United States and restore the exporter's dominance in the oil market by crushing the U.S. tight oil boom which requires high prices to be profitable.


  8. No, Saudi Arabia is really trying to help the United States in its fight against ISIS by showing its support for the United States and Europe through lowering oil prices and by making the price that ISIS gets for the oil products it now controls lower. The lower price is also harder on Iran which requires high prices to sustain its government revenues.


  9. Saudi Arabia is simply trying to defend its market share in the face of waning demand by continuing to pump oil at current levels and offering discounts to customers.
Of course, the above answers aren't necessarily mutually exclusive. People and countries can have multiple objectives served by the same action. And, some or all of the above assessments could be wrong or at least of very little explanatory value.

Now, I'll weigh in. It seems entirely likely that the Saudis are being opportunistic. Like many oil exporters, they need high oil export revenues to pay for their government expenditures, much of which consists of food and fuel subsidies and social programs designed to keep the public docile. In the face of what looks like declining demand, rather than cut production to maintain prices as they have done in the past, they've decided to maintain their market share worldwide by cutting prices. This has the benefit of making much American tight oil production uneconomic, thus discouraging new drilling.

The Saudis know something very important about the U.S. tight oil drillers. Most of them are independents who are loaded with debt and don't have the financial wherewithal to weather a period of sustained prices below their cost of production. They will quickly reduce their drilling to only those prospects which seem as if they might be profitable at these new lower prices.

That will pave the way for sustained higher world prices later as growth in U.S. oil production comes to a halt. After the damage is done, the Saudis will try to bring the price back up.

It's always possible that the Saudi strategy will fail because what's really happening may be the first stages of a colossal economic and financial crash that will take the world economy into prolonged recession. That would bring the price of oil down to levels not seen in a decade where they might stay for a considerable period.
I'm not predicting that. And, in fact, none of what I've written may have any validity. Even though the Saudis have publicly stated that they are defending their market share, they may not be telling us exactly what their aims are. Saudi acquiescence to lower oil prices may simply be having consequences the Saudis don't intend, but can't avoid.

In truth, the whole issue of oil prices is too complex and too lacking in transparency to be discussed intelligently when it comes to short-term price movements. I am reminded of the tale of the blind men and the elephant of which the last stanza of a poetic version is quoted above.

But, as I say, price makes the story.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.


About The Author - Kurt Cobb is the author of Prelude, a peak oil-themed novel, and a columnist for the Paris-based science news site Scitizen. His work has been featured on Energy Bulletin, The Oil Drum, 321energy, Common Dreams, Le Monde Diplomatique, EV World, and many other sites. He maintains a blog called Resource Insights.  (EconMatters author archive here.) 

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