21st Century Wire
Keep an eye on this latest market move, as it indicates where inflation could be heading in the run up to 2014…
MEMORIES OF THE 1986 PRICE CRASH
Like the US debt ceiling saga – with the only possible result being more debt – the ultra-magic triple-digit dollar oil price of US WTI, and of course more for European Brent, needs extraordinary measures to stay that overblown. In the case of the US debt mountain the Fed does the extraordinary (over)blowing, but for oil WTI counts on heavy lifting by leading members of Wall Street’s oil market manipulator clique – often referred to as “investors” – who not so long ago forecast WTI as easily able to attain $125 per barrel by December 31st.
So the shading of New York oil prices below $99.99 on 21 October was something of an historic event…
Even by mid-morning, New York time, on 21 October the plunge protection team was clearly at work trying to repair the damage – because falling oil prices are a challenge to New Normal.
The nightmare for new normal oil and its unreal pricing – totally unrelated to natural gas and coal prices due to oil being so “noble” – would be a repeat and remake of the 1986 price crash. This featured plenty of the parameters, and the same Mid Eastern and other actors, we have today.
The official story for what happened in 1986, which resulted in a cool 67% or two-thirds reduction of the oil price through 6 months, followed by 13 years of low prices, can be given but doesn’t have to be believed. The story says Saudi Arabia “abandoned its swing producer role”, cutting back its production from a little over 10 million barrels a day (Mbd), close to today’s claimed 11 Mbd, to just 2.3 Mbd by August 1985, because of increasing price weakness signals in the market, or at least clear signs of reduced Saudi revenues. The story continues that Saudi Arabia had been tinkering with pricing options and alternatives, from compensation-offset trade deals, to increased refining action to reduce crude as a percentage of exports, to netback-pricing concepts tying the crude price to the value of refined petroleum products in certain markets, in a global refining system like today’s but more extreme – beset by high costs, overcapacity, outdated technology, and so on.
In fact the most basic problem was soft global demand for crude, which had not recovered from the 1979-83 recession. The Saudi action of hiking its production above 10 Mbd had spurred other OPEC members to increase crude production and offer their own barter-offset and netback-pricing deals for buyers. World supply and stocks of crude and products rose through late 1985 and continued into 1986. The average per-barrel FOB (free on board) price for OPEC crude oil dropped from around $23.45 in December 1985 to $9.85 in July 1986 and for some crudes, and some buyer markets, it dropped further than that. Prices for crude oil from nonOPEC countries of course followed the same track. A 13-year price decline ensued
ENERGY ECONOMICS VERSUS GEOPOLITICS
Rather similar to today, the US-Saudi prime concern of the day was the Iranian menace, even if Syria’s al-Assad of the day, called Hafez was less of a problem than his son Bashr. In 1985 the Iraq war effort against Iran in their war which started in 1980 was weakening by the day. The war was partly financed by Saudi Arabia and mostly armed by the US, including the supply of chemical weapons to Iraq, but by late 1985 was failing and tapering down. Iran had not been beaten. There was stalemate.
Through the period to late 1985 and into 1986 the Middle East “war risk premium” on oil was often estimated at around $10 a barrel, or more. Today’s estimate is about the same. By late 1985 however the taper-down of the Iran-Iraq war was becoming hard to ignore, eroding the risk premium, but Saddam Hussein’s demands for financing, loans and weapons, and even fighting men to throw at Iran were higher than ever. A collapse in oil prices was about the worst thing possible for keeping the war popping – but the war popped its clogs and fizzled out, in major part due to insufficient funding, made worse by falling oil prices!
The impact of the oil price collapse on the US oil sector was dramatic. Crude prices 60% lower reversed the upward trend in US oil production that had operated for the previous 5 years. High-cost wells, made economic by the doubling of oil prices in 1978-1980, became unprofitable and were shut in. US oil imports soared, from 3.2 Mbd in 1985 to over 8 Mbd by the late 1980s, and peaked at 9.1 Mbd in year 2000 except for imports from the Gulf Arab states, which peaked in 2003, according to US EIA data.
Through 1986-99 the collapse of world oil prices had most and first affected OPEC crude. OPEC oil exports to the US grew and overall oil consumption of the US rose from in those 13 years by nearly 4 Mbd, from 15.7 Mbd to 19.5 Mbd.
The energy economics of the crash were drastically simple. When oil prices decline, Saudi Arabia pumps less and the US imports more. When oil prices rise Saudi Arabia pumps more and the US imports less but as the 1986-99 period showed, OPEC producers apart from Saudi Arabia taper down less, or not at all, to try conserving oil revenue totals. Non-OPEC producers can also react this way, even in high cost oil provinces like the North Sea where oil output went on rising as prices crashed and stayed high throughout the 1986-99 period. The USSR’s production through the 1980s was rarely below 11.6 Mbd, and only seriously declined from 1990.
Oil geopolitics in no way has to converge and comply with the energy economics. Mainly for internal domestic political reasons, Saudi Arabia soon threw in the towel on its production-cutting effort or “price discipline” role, defending prices by producing less. From 1989 to 1991 it hiked average daily output by 3.1 Mbd, to 8.1 Mbd, and throughout the 1990s with prices often down to $10 – $15 per barrel it held its average output at around 8.1 – 8.4 Mbd. The claimed “target price” agreed by OPEC and promoted by Saudi Arabia, was $18 per barrel, but this was rarely attained for a period lasting 13 years from 1986.
WILL IT HAPPEN AGAIN?
Theoretically it would be totally impossible to have a comparable more-than-60% fall of oil prices, today, with prices cut to around $40 per barrel, and held at that low level for over a decade. The crash of oil prices in 2008-2009 was a radically rapid decline-and-rebound event.
Today, both Saudi Arabia and Russia work on short national financial and economic fuzes, and the US economic fuze is so short that any massive cut in oil prices – creating a wave of panic in the US domestic oil industry – would likely not bolster economic growth or lead to a big uptick in US oil consumption. In 1986 world oil production and refinery overcapacity was huge, but the overhang is not so large today. The price crash of 2013-14 would therefore be more restrained, and could not feature a cut of oil prices by more than about 33% from present prices.
Nevertheless, today, both Saudi and Russian oil output are at record highs – and US output also. The smaller OPEC producers, and a host of small non-OPEC producers are often at or near record output. The potential for oil stocks growing radically outside the US, and potentially also in the US, certainly exists and reporting disclosure of radically rising crude and refined products stocks will always add further downward pressures on prices if and when they are already falling.
The Middle East war risk premium, assuming it is around $10 per barrel can be heavily cut given the basic US-Russian entente or deal to not bomb Syria and remove its chemical weapons, whatever Saudi Arabia might think of that. This would take oil prices to about $89 per barrel for WTI. About another $10 below that price level we start approaching actual US shale oil producer prices, making further declines less easy, but still possible.
The likely sustainable floor price – meaning a long term depressed price level – could be as high as $70 – $75 per barrel, after trading swings and plays have turned down.
HELPED OR HINDERED BY THE DOLLAR?
Conventional oil analysts and trader lore says that if the USD declines, oil prices in dollars normally rise “mutatis mutandis” but even if we forgot our Latin, the outlook for the USD plunging – against what? – presents a lot of intellectual problems. Against oil is what the oil bulls hope.
Quoted on Pravda.ru, October 16, scholar Mikhail Khazin said: “Those who are professionally engaged in economic matters, in one voice say that there are not years, but months or even weeks left before the collapse.” To be sure he meant a collapse of the USD and its role in world trade – especially oil trade. Conversely, Khazin said nothing at all about the Russian ruble becoming the world’s new petrodollar, nor the CNY-RMB, nor gold – and we can tell him that oil-gold trades will be hampered by persistent weakness inside the bullion market, upstream corporate debt for miners hitting extremes, but revenues declining, and soft gold mining stock prices being sure and certain for some while forward.
Forecasts that the USD is going to tank – against what? – face so many hurdles in the real world we can bet with the contrarians that the world value of the dollar will rise a little, if not a lot, in coming days and even weeks. Dragging down the oil price.
In a normal world, nothing like New Normal, as pointed out by Alistair Macleod in a long interview with Chris Martenson on ‘Peak Prosperity’, October 19, the role of QE worldwide and whether this concerns the US Fed, the ECB, the BOE or the BOJ, has reached a saturation effect in artificial wealth creation. It is now only a wealth transfer operation. Only those players close to the money spigot will now get the spinoff or “trickle down” from printed money.
This is a deflation crisis, likely or certainly followed by hyperinflation, but presently a deflation crisis. Outside the trickle down, everywhere else in the economy, local and global, we get deflation. Oil prices will therefore deflate – not inflate.