This morning, I stumbled across this thinkpiece from our English-type cousins on the other side of the globe. I simply had to share.
In particular, there are two items to highlight. First, the title: “When OPEC cuts output, oil prices will begin to climb.” I draw your attention to the fact that this is in a periodical apparently known as the Financial Review. Thank you, Captain Obvious!
There is almost no simpler economics lesson in the world than “lack of supply comparative to demand generates higher prices”. Scarcity from literally anywhere of any commodity generates higher prices. Increased supply and decreased demand leads to lower prices… of… well… anything!
The second piece of hilarious “information” is the notion that “OPEC has been flooding the world with oil”. Hmm… Yes… OPEC, the most convenient straw-man in the history of markets, is to blame for all our ills.
Or… perhaps, as we all now know, America’s own much loved oil industry is, in the largest sense, to blame for the current glut. OPEC has been producing around 30 million barrels of oil for almost a decade now. The newly problematic supply, then, isn’t from OPEC; it’s that America surpassed its output from the 1970’s. You see, as you can find argued here much more eloquently, oil producers historically produce every ounce of oil that available technology allows (proclamations to the contrary notwithstanding).
Saudi Arabia was, for a very brief time, the exception that proved the rule… In it’s role as the marginal swing producer, it could (to a small extent) support the world oil price by curbing its own production. Other OPEC members would promise to do so themselves, only to relentlessly cheat on their end of the bargain in an effort to snag market share. It’s not that these other members wanted to cheat, it’s that they couldn’t help themselves. Running oppressive regimes is so expensive!
So, if OPEC will not (or cannot) cut their own oil production, then where will the scarcity necessary to create price support come from? Well, from the same people who created the problem to begin with! (I don’t usually end sentences in prepositions as a matter of course… this time, however, I’ve doubled down. Deal with it.) Once we start seeing capitulation in America’s oil industry, with the concomitant decline in production, we will start to see some price support. If one is waiting on OPEC to come to the rescue, one is looking in the wrong direction. (I’m looking at YOU, Financial Times.)
Next, I came across this piece of editorialism on Oilprice.com. Both Oilprice.com and the author of this article, James Stafford, typically stake positions with which I tend to agree. This time is an unusual exception. In the piece, as one can see from the headline, Stafford argues that a war between Saudi Arabia and Iran could send oil prices to $250. This statement, taken in isolation, is true. Stafford also mentions toward the end of the piece that the war is, at present, a speculative issue – again, true. Finally, and once again correctly, Stafford notes that these two players are already engaged in proxy battles with each other in Syria and Yemen. These are the items with which I have no disagreement.
The overall position of the piece, however, seems to suggest by implication that this is likely enough to deserve our attention. This is the point where I diverge. I will say it here definitively: Oil will not go to $250 anytime in the near future. It will not go there because of scarcity from conflicts between OPEC members. It will not go to $250 because of demand-side issues. It will not go because of supply disruptions at home. It. Won’t. Happen.
If markets were to be really spooked by the notion of war between these two countries, we would have already seen price support by the very proxy wars we’ve observed between the Saudis and the Iranians already.
Instead, the fundamentals of the industry indicate that we have not yet achieved the market clearing price. The market for oil has been oversupplied by 1.5-2.0 million barrels per day for over a year… NOTHING is going to change this fact. The oversupply already happened. It’s still happening. The invariability of the past seems like a simple notion with which reasonable minds could agree; however, every I day I come into the office and see articles like this one that pose these insipid hypotheticals. Then, as here, the authors trot out some industry expert, usually a trader (who desperately wants a war to to save his portfolio), who readily agrees with the predetermined focus of the piece.
I really have nothing against this overall strategy. I too am an internet blowhard… If I could find some poor schmo to agree with my point of view, I would have no problem with interviewing said schmo and making them agree with me in return for printing their name next to the title “industry expert”. Seriously, just e-mail me and I will happily claim you’re an expert in something just to get some corroboration for the next post.
Could an all-out-war between Saudi Arabia and Iran cause a price spike? Sure! You know what else could cause a price spike? If the oil supply fairy came down from Fairytown and magically wished away the 3 billion barrels already in storage!
Instead of looking to possibilities, we should (as Keynes argued) look to probabilities. As I have argued before (and been supported by both other authors and, you know, DATA), the incentives to these players skew the other way. Even if war broke out between these nations, you have to think that they understand incentives enough to hesitate to destroy the other’s production capacity. It’s the same “mutually assured destruction” that kept the Cold War, uh, Cold. If Saudi Arabia drops bombs from it’s F-16 fighters on the refineries in Iran, it can expect MiG’s from Tehran to strike back within minutes. For that reason, it is unlikely to engage in this action directly.
Again, the incentives skew the opposite direction… If these countries maintain the status quo, then Iran is likely to pump all it can to capture market share. Iran has not realized much from it’s oil industry since the 80’s anyway, so this is free money to them – regardless of the current price! Saudi Arabia, meanwhile, is unlikely to allow a Shiite theocracy steal market share from it without a fight… this creates the incentive for them to maintain production and offer discounts to maintain market share. If open hostilities break out between the two then they will need increased production to put into tanks and planes – and will also need increasing oil revenues to finance the conflict. Pick a door, one or two, either one leads to increased production… Door number three just hides a donkey (don’t pick door #3).