On June 1, The Wall Street Journal led with this story: “OPEC Clout Hits New Low.”
The piece states in concise form what has become the conventional wisdom about the world oil markets of 2015. Prices of crude are low and hapless OPEC can do nothing about it, given a “half-decade surge in U.S. oil production and weak international demand.” The barely-hidden implication of this line of thought is that the low prices will get lower.
This is a triumphalist narrative for some Americans. Indeed, the story quotes the Governor of Colorado, John Hickenlooper, saying: “OPEC is the past, and its leverage over the economies of the world has been significantly diminished.”
There may be a germ of truth to this, but it has great capacity to mislead.
Yes, OPEC as an organization may have lost its salience. But there is no reason to believe that the one government closest to OPEC’s heart, Saudi Arabia, has lost any. Indeed, the present world glut in the world exists due largely to Arabian policy decisions.
Rivalry and Policy
The Saudi monarchy is responding both to short-term pressures and to a longer-horizon understanding of its situation. Short term pressures: Iran is its great rival for influence in the Gulf region, and the Saudis have lower costs than the Iranians. As a consequence, the Saudi’s can survive lower prices more readily. Heck, they can make a profit even if world prices go to $35 a barrel. They can wait and keep their production humming, allow the resulting oil glut, and live with the low prices knowing that the real pain is felt by their Persian rivals.
It is also unlikely that the Saudis are thrilled with the prospect of Iranian development of nuclear capacity, so in some circles they may at last smile indulgently at the sanctions regime maintained by P5 + 1. Yes, there is some sign that the P5+1 powers may be ready to back off from the sanctions, but that is not at all certain and, if it does happen, that may only confirm the House of Saud in its determination to impose its own via a price war.
In March 2015, Saudi oil production increased to 10.3 million barrels a day. That isn’t the desperation of a county that has lost clout. It is the deliberate decision of a country that is exercising clout. Saudi Arabia is determined not to be “the past” any time soon. That is why it is at its highest level of production since the Joint Organizations Data Initiative began keeping track.
In their moments of Grand Strategy, the Saudis are surely aware of the “resource curse,” the unhappy fate that often afflicts economies based on the extraction of valuable minerals. An economy can become stuck to the single resource in which it has a comparative advantage, just as insects become stuck to flypaper. The extractive industry – in this case oil – can demonstrate decreasing returns to scale, and can fail to spark development in other areas of the economy. When in time the mines are just holes in the ground, the wells have run dry, or the action has simply moved elsewhere: what then?
In 2000 the one-time Minister of Oil, Sheikh Ahmed Zaki Yamani, (who had been maneuvered out of office in 1986 and who accordingly had had a lot of time to reflect) told a reporter, Gyles Brandreth, that by 2030 “there will be a huge amount of oil – and no buyers.” At that time, he said, the “oil age” will have come to an end, and grave difficulties will await the Saudis.
If his countrymen have come to share that view, one rational response to this concern is, precisely, to keep prices low. That may be the best way to allow for other flowers to bloom in the desert, to allow for the development of industries that will still be around in 2030.
So: whatever may be true of OPEC, the Saudis haven’t been forced into passivity. They are exerting the considerable significance they still have in world markets, and are doing so in a way that may well prepare them for a time when their sway will have to come from sources other than black gold, Texas tea….
What is the significance of this line of thought for the hunt for alpha? First and most obvious: don’t trade on headlines, not even headlines in the esteemed Wall Street Journal. Second: although the OPEC-is-dead triumphalism of Hickenlooper might lead one to believe that the collapse of the price of crude is sure to continue, a more measured view of the underlying reality would say: whoa pardner. The Saudis may well have brought the price as low as their policies, long and short term, need it to be. There is no further gain on the downside. There may be a trade in the reduction of volatility in the markets near term.