Is OPEC Facing A Bear Market?

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Some analysts are worried that OPEC is facing lower prices for oil once Libya begins producing again and that will endanger the social order in places like Saudi Arabia where they need high oil prices to survive.

The latest news from Libya is a claim they will be producing 500,000 bpd by the end of October. While that may be wishful thinking nobody really knows what obstacles they have to overcome to put their oil back on the market. It is entirely conceivable they could hit that target but wishing it to happen and making it happen are two different things.

OPEC saw the price for its basket of crude fall to $99.65 on October 3rd. That was the lowest level for the year and closely relates to the price of Brent crude. The problem they face when Libyan crude comes back online is the potential decline in price if the world economy continues to stumble.

Getting the first 500,000 bpd back online will not be a major obstacle because it will take many months to replenish inventories depleted by the months of war. Inventories all over Europe have shrunk as they were forced to use stockpiled oil rather than buy light crude on the market.

After that first 500K comes back online there are plenty of estimates for the remaining production. Libyan officials believe they can get the full 1.6 mbpd back into production in 15-18 months. If that is the case then there is no problem for OPEC because global demand will increase by 1.4 mbpd over the next 12 months assuming a major recession does not appear.

The demand for oil increases by about 1.5 mbpd on average every year. Some more, some less but it always increases except in case of war or recession. Several European countries are falling back into recession as a result of the austerity process. If their crude demand falls by -10% it would mean global demand growth might only be 1.0 mbpd in 2012.

The key is the USA and China. If the U.S. were to fall back into a "normal" recession we might see demand decline by 300-500,000 bpd for several quarters. It would be temporary but it would happen. Coupled with weakness in Europe it would probably reduce demand growth to only 700,000 bpd in 2012.

If China were to suffer a hard landing, which is not likely under most scenarios, it could reduce demand "growth" by another 300-400,000 bpd.

Fortunately all those scenarios happening together are not likely. The recent U.S. economics have been better than expected. It appears we are continuing to grow only at a slower pace. China had two PMI reports last week, one from HSBC and one from China's agency. The HSBC report showed China's manufacturing to be only slightly negative for the fourth consecutive month. Definitely not a challenge since China is growing at roughly 8.5% per year. The government report showed China had resumed manufacturing growth by a small percentage. I have a hard time believing China's government reports but even using the HSBC report it suggests oil demand will continue to grow.

OPEC needs this demand growth to continue to keep prices over $100. During the recent Arab Spring several countries announced massive social programs to keep the population favorable to the current government. Saudi Arabia announced $130 billion in stimulus from building hundreds of thousands of homes to hiring 50,000 policemen to keep the peace. That was a thinly disguised make work program to provide hiring for the young and restless doing the protests.

Saudi Arabia produced 9.85 mbpd in August. That is the most since 1980 and 22% over its quota. As long as economic problems do not worsen they will likely continue to produce at that level. They need to produce the revenue to keep those social programs going.

OPEC nations are on track to earn over $1 trillion in 2011 from oil and gas sales. They will spend more than $150 billion on the newly announced social programs. That is a major tax on their revenue and they need to keep those revenue streams flowing.

The IEA claims the "call" on OPEC oil will decline to 29.8 mbpd in Q2-2012 from the current 30.3 mbpd. It will be 30.5 mbpd for the other three quarters in 2012. Those estimates are under constant revision but the call today is about 30.3 mbpd so even with the projected economic weakness in Europe, China and the USA there was no material decline in estimates.

If anybody is going to cut production it will probably be Saudi Arabia since they have the most production and are well over quota. Several analysts believe most OPEC nations are producing at 100% even though they will not admit to being over quota.

There is a danger to OPEC if economic conditions worsen but there is also a danger if conditions improve and demand increases. When prices rise as excess capacity shrinks the global political pressure begins to grow. Eventually they are going to have to admit they don't have the excess capacity and that is when the real problem will appear.

For today their only problem is hoping it takes Libya 15-18 months to return to full production. That time frame is perfect because it matches the growth in demand. A faster return could pressure prices but it will only be temporary.

Jim Brown

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