OPEC, Human Nature And A $55 Brent Forecast

By John Richardson

OPECLogoHERE is a quote for you: “Everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted.”

This supports the argument we have been making over the last two months that human nature matters as much as data in helping us decide where oil prices are heading.

We knew, before OPEC’s decision not to cut oil production, that:

•For Saudi Arabia, this was a geopolitical rather than an economic issue.

•They really need to close down higher cost US shale-based output and thus restore their export position to the US.

•If they remain excluded from the US market in the long term, who will look after their global political and military security?

•The Saudis have depended on the US for this security ever since the pivotal meeting between Ibn Saud and Franklin Delano Roosevelt in February 1945.

•At that meeting, the US promised long term political and military support in return for Saudi crude.

•But the shale revolution, of course, means that the US no longer needs Saudi crude – as long its higher-cost producers remain in business. Net oil imports to the US have fallen since 2007 by 8.7 million barrels a day, “roughly equivalent to total Saudi and Nigerian exports,” according to a recent Citigroup report.

•It was argued that Saudi Arabia needed crude to be at around $90 barrels a day to meet the cost of its social programmes.

•But Saudi Arabia knew that it could not repeat the 1981-1985 mistake of trying to stabilise the market by cutting production from 10 million barrels a day to 2 million barrels a day.  All that happened was that they lost market share to their fellow OPEC members.

•This is a “long game” for Saudi Arabia. They, of course, have the lowest production costs in the world and have ample financial reserves to withstand a sustained period of much-lower oil prices.

This morning, of course, people will be returning to their data to try and re-calculate the new “break-even price” below which high cost US shale-oil production will shut down – and thus restore oil prices to where they think they should be: Close to $100 a barrel.

This is an essential task, Data still matters, of course –  hugely.

But human nature also counts here as well. As a further reminder:

•It depends on what return on investment you think that producers in the US will be satisfied with.

•What if they end up being happy with much lower rates of return than most people have forecast?

•What happens if they keep on producing, as oil prices continue to tumble, in order to protect their market shares?

•And why shut down when you are still earning some money, even if it isn’t much? You will still have to pay your debt back if you are not running, and, of course, if you are not running, you will have NO revenue.

•Isn’t it therefore much better to “tough it out” and to wait for a recovery in oil prices?

•And what if some shale oil producers go bust? Might their debt be written off and might they then be taken over by private equity players? These new owners would then only have to cover variable costs.

Also, put your smartphone down, switch your computer on standby and take a walk down any street in the emerging world or in squeezed “middle America”. You will then realise that the world was never, really, able to afford oil close to $100 a barrel oil. Today’s price collapse will in the long, therefore, be fantastic news for global growth.

In the meantime, though, some chemicals companies that bought raw materials on the basis of much more expensive crude back in September face severe financial distress (much more of this on Monday).

How low might crude now go? Brent at $55 a barrel, according to Credit Squeeze.

And, finally, on the quote I started this post with, one might think, given its emphasis on the intuitive nature of things that it is from some arts-focused person – or maybe a social scientist.

Actually, though, it is from Albert Einstein. He was pretty good at numbers – and realised their huge value –  but also recognised that you cannot look at numbers in isolation.

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