OPEC

All you need to read.

European Indices are trading up at the midpoint of the session following strong performance from financials, however, Italian bond auction results dampened this effect after failing to replicate the success of the Spanish bond auction yesterday with relatively lacklustre demand. There has been market talk that this lull in demand for Italian bonds is due to technical error preventing some participants from bidding in the auction, but this still remains unconfirmed. Heading into the North American open, fixed income futures are still trading higher on the day having seen the Bund touch on a fresh session high and with peripheral 10-year government bond yield spreads widening ahead of the treasury pit open. Markets now anticipate the release of US trade balance figures and The University of Michigan confidence report.

Imagine pensions not paying retiree funds, insurers not paying claims, and banks collapsing everywhere. Sounds like fun? I will be discussing this live on RT's Capital Account with the lusciously locquacious Lauryn Lyster at 4:30pm.

Markets are moving positively across the board today following comments from Fitch, dampening speculation that France may be downgraded from its Triple A status. Fitch’s Parker commented that he does not expect to see France downgraded at all throughout 2012. However he added that there are continuing pressures for France from national banks and EFSF liabilities, Parker also reinforced German confidence stating that Germany’s Triple A rating is safe. Markets were also experiencing upwards pressure from strong French manufacturing data performing above expectations and successful Austrian auctions today, tightening the spread between France and Austria on 10-year bunds.

All you need to know.

In keeping with the theme of everything decoupling from everything else these days, a comparable decoupling pattern could be observed in China's December trade data, which experienced a surprising jump in its trade surplus from $14.5 billion in November to $16.5 billion in December, even if exports broadly slowed down and grew at the slowest pace in 10 months. This number was quite odd as it represents almost double the consensus forecast $8.8 billion, predicated by a matched slow down in imports which were up only 11.8% Y/Y, the smallest rise since the October 2009 decline of 6.4%. The odd jump in the trade surplus appeared at a time when many were expecting that the slowing Chinese economy would be well on its way to shifting from surplus to deficit, leading to a devaluation of the CNY (as opposed to the constant badgering form the US and Chuck Schumer demanding a revaluation of the renminbi). Furthermore, as the year winds down to the Chinese Near Year in February, this has been a traditional time when Chinese surpluses decline and go negative, even in good years (see 2010 and 2011). Yet a quick glance at China's two primary trading partners: the US and EU does not reveal anything peculiar: both were either flat or saw just a modest drop in the trade surplus - good news for anyone concerned if the European slowdown would hit the country's largest trading partner. Which is where the decoupling occurred, as the surplus soared in the "rest of the world" or the non-EU/US category. As can be seen below, December is traditionally a month when the surplus contracts and approaches the flatline. Yet this year, oddly enough, the December surplus doubled from $5.8 billion to $11.4 billion. Just who is it, outside of the US and EU, that suddenly saw a pressing need for Chinese imports?And yet all of the above is likely just minutae when one considers something far more important: Chinese Oil imports. As the chart below shows, sooner or later excess capacity within the OPEC system is going to disappear. And then it gets really interesting.

Previously we heard Pimco's thoughts on the matter of an Iranian escalation with "Pimco's 4 "Iran Invasion" Oil Price Scenarios: From $140 To "Doomsday"", now it is the turn of SocGen's Michael Wittner to take a more nuanced approach adapting to the times, with an analysis of what happens under two scenarios - 1) a full blown EU embargo (which contrary to what some may think is coming far sooner than generally expected), and the logical aftermath: 2) a complete closure of the Straits. The forecast is as follows: 1) "Scenario 1: EU enacts a full ban on 0.6 Mb/d of imports of Iranian crude. In this scenario, we would expect Brent crude prices to surge into the $125-150 range." 2) "Scenario 2: Iran shuts down the Straits of Hormuz, disrupting 15 Mb/d of crude flows. In this scenario, we would expect Brent prices to spike into the $150-200 range for a limited time period." The consequences of even just scenario 1 is rather dramatic: while the adverse impact on the US economy will be substantial, it would be the debt-funded wealth transfer out of Europe into Saudi Arabia that would be the most notable aftermath. And if there is one thing an already austere Europe will be crippled by, is the price of a gallon of gas entering the double digits. And then there are the considerations of who benefits from an Iranian supply deterioration: because Europe's loss is someone else's gain. And with 1.5 million of the 2.4 Mb/d in output already going to Asia (China, India, Japan and South Korea) it is pretty clear that China will be more than glad to take away all the production that Europe decides it does not need (which would amount to just 0.8 Mb/d anyway).

The folks at Religare Capital Markets have put together one of the better cheat sheets on a region that most of the big banks largely ignore: the Middle East, where day after day we get new and more troubling headlines of escalation, usually involving Iran and Israel. And since at the end of the day, in a resource-strapped world, the bottom line is always about energy, and oil, what happens in the MENA region is arguably far more important at the end of the day than who prints how much electronic paper/linen. But most important is probably the following analysis charting the probability of an attack of Iran by either Israel or the US. We were quite surprised to find that in Religare's opinion the probability of an Israeli-sourced attack on Iran hits a high of 50% sometime in early February, with the US contributing about 20% with a peak in May and just before the presidential elections. This is how they explain it: "The probability of an attack on Iran is now higher than ever. The only solution to the current crisis, diplomacy, is off the table due to politics and the focus is now shifting to regime change. We see the probability dropping mid-year, although US elections could increase the probability of a US attack significantly (unless Ron Paul steams ahead), as will Iran’s likely decision to move their centrifuges to reinforced facilities in Qom if not handled correctly (likely mid-year). We reiterate our view that the fallout may not be as bad as expected from an Israeli strike, horrendous from a US one." And if they are right, what happens to oil will likely be the biggest catalyst of events in 2012 - a topic PIMCO has already had some extended observations on.

According to Bloomberg, instead of the crude released by the Strategic Petroleum Reserve going into circulation, "Some of the oil being released from the U.S. Strategic Petroleum Reserve to bring down prices may be held by traders for later sale rather than sent directly to refiners for processing into gasoline or other fuels." In other words, instead of being held in storage by the US government, the oil which is supposed to be used immediately to alleviate supply pressure, will be held in storage by the Too Big To Fails, most likely in storage tankers floating offshore, just like back in late 2008, early 2009, to be released only when the prevailing price is sufficiently higher (not to mention courtesy of added demand from the SPR as it seeks to refill it 5% depleted inventory). But wait, wasn't the release predicated upon it being a supply emergency with a need for immediate release? Ironically it is JPM's own Lawrence Eagles, head of oil research, who said that "every additional barrel of oil stored in the U.S. is a barrel that does not need to be imported, ultimately freeing up barrels to move to Europe. It worked very effectively after Hurricane Katrina in 2005 and should do so this time around." What he did not specify is held by whom. And here is the kicker: "The DOE has no preference for bids from refiners versus traders and both have participated significantly in past sales,” an official from the Energy Department wrote in an e- mail. “There is nothing to stop buyers from putting the oil they have purchased into their own storage." Well in that case the DOE would be advised to know that JPM, which is expected to bid and purchase a substantial portion of the crude to be released, together with Goldman Sachs, have already been alleged to be a supply-limiting cartel when it comes to LME commodities. In its infinite stupidity, the administration and the IEA have merely moved supply constraints from one oil cartel, OPEC, to another: one led by the Too Big To Fail banks.

Last week's dramatic decision by the US administration to strongarm the IEA into releasing strategic petroleum reserves (of which the US would account for 30 million barrels, or half of the total), is nothing but yet another example of the hobbled and incredibly short-sighted thinking that permeates every corner of the Obama administration. Because as the WSJ reports, "the move by the U.S. and its allies to release strategic reserves of oil could provide a much-needed shot in the arm for the U.S. economy, but risks inflicting lasting damage on the already tense relationship between oil producers and consumers." The move comes on the heels of the dramatic collapse in OPEC talks in Vienna two weeks ago when Saudi Arabia was effectively kicked out of the cartel, further confirmed by reports that the IEA consulted with Saudi (and China and India) in advance of its decision (more later). Additionally, "OPEC and the European Union are due to hold an energy summit in Vienna Monday that will be the first official meeting of producers and consumers since the IEA's move, and will provide a platform for OPEC members to express their disquiet over the stocks' release. However, OPEC's biggest player, Saudi Arabia, won't be present." Make that former player, in an organization now headed by the previously #2 producer, Iran (which just happens is not all that pro-US). The biggest threat, however, is that in direct retaliation against the IEA's cartel-like decision, which comes at the expense of the remaining OPEC countries, is that as Zero Hedge suspected, the next step will be a more than proportionate cut in crude production by OPEC: "Some analysts speculated that OPEC could respond to the IEA release by cutting output to offset the increased supply." What happens next is complete Nash equilibrium collapse, with a high possibility of a 1973-type OPEC oil embargo announcement in the immediate future.

Gold is marginally lower while silver is showing strength again today after yesterday’s 'worst ever' OPEC meeting ended in disarray and saw oil prices surge. Markets await today’s ECB rate decision and signs as to whether interest rates are set to rise sooner rather than later. Signs of an interest rate rise in July should see the euro and gold rally versus the dollar. The precious metals are also likely to be supported by further sharp falls in peripheral markets bonds, particularly Greece, this morning. While all eyes are on the ECB today, there was a reminder late yesterday that it is not just the Eurozone that is struggling with debt. Fitch Ratings said it would put US debt on watch in early August if Congress fails to raise the federal debt limit. OPEC, the oil cartel’s increasing impotency was seen yesterday when Libya, Iraq, Angola, Ecuador and Algeria sided with increasingly influential Iran and Venezuela rather than Saudi Arabia and its allies Kuwait, Qatar and United Arab Emirates. Also, Japan’s nuclear crisis is leading to a decline in nuclear energy production, possibly long term in nature, and China’s massive drought has led to marked decline in hydroelectric energy production. There is increasingly the real risk of an oil crisis especially given the very tense geopolitical situation in North Africa and the Middle East. Separately, Iran announced it planned to treble its capacity to produce highly enriched uranium which alarmed western powers and was deemed ‘provocative’ by one international relations analyst. Oil prices have risen over 10 times since 1999. For gold prices to just catch up with the price increases seen in ‘black gold’, gold would have to rise over $2,500/oz (10 X $250/oz).

Today the world is transfixed with the dissolution of OPEC courtesy of yet another polarizing response to the most recent set of US MENA policies, with Saudi siding with the US (it has no choice in this: recent violent developments in the MENA region means Saudi Arabia is now even firmer attech to Uncle Sam's armed sleeve), yet the truth is that this is a completely non-event from a pure crude supply/demand perspective. Why? Because the real marginal supplier, in light of OPEC's secular decline in output, has been Russia for a long time. The Globe and Mail's Jeff Rubin explains: "Other than a gratuitous gesture to their concerns, any announced OPEC production increase isn’t going to pump more gasoline into U.S. gas tanks or, for that matter, the tanks of motorists anywhere in the OECD... Khalid al Falih, chief executive officer of state-owned Saudi Aramco, recently warned in April that at the country’s current rate of growth in domestic oil consumption, Saudi Arabia would burn a staggering 8.3 million barrels a day of its own oil by 2028. That is almost its current level of production." In other words, Saudi would promote unilateral actions regardless of the other 6 countries that just isolated the Middle East country, simply to keep its population happy with ever greater bribes, but also due to the expansion of its own economy (as transient as it may be). The real story is here: "Russia, the one country actually capable of producing 10 million barrels a day, isn’t even at the table at the OPEC meeting. And it’s been Russia that has been adding the most to world exports over the better part of the last decade as OPEC exports have faltered." In other words, now that the former cartel is finished, and supply bickering and uncertainty portend extreme crude volatility, Russia's role in the energy output scene, and thus in political in general, is about to become that much more important.

The worst nightmare of crude bears has just come true:

• OPEC secretary general says OPEC unable to reach consensus to boost production
• OPEC delegate says OPEC has no consensus for agreement
• OPEC president says some in OPEC believed should have had production increase, other said more time needed to asses
• OPEC secretary general says OPEC spare capacity down to 4-4.5MBPD after Libya
  
• OPEC president says final proposal was to wait for about three months to asses situation
  
• OPEC president says Status-Quo outcome unwelcomed by some members
  
• OPEC president says effective OPEC decision is a roll-over
  

This is what happens when, as we wrote yesterday, the OPEC is no longer a cartel but a loose gathering of dictators who do their best/worst to boost/scuttle Obama's re-election chances. Look for crude to do the HFT levitation on the news.

Contrary to ongoing wideranging skepticism, Saudi Arabia continues to posture that not only does it have substantial excess capacity, but that it will bring it online any... minute...now. After all, Saudi owes the US a big favor (i.e., lower gas prices) in exchange for America's (or rather its Fifth Fleet) continued presence in Bahrain, which even those living in a cave know has been under a full media blackout to keep the ongoing religious tensions under wraps and keep the Saudi-Bahrain border safe (not to mention the Ghawar oil field). So even as Saudi had promised to hike its output as Libyian production went offline only for it to be discovered that the country had in fact lowered production, so now too the song and dance has hit fever pitch. Reuters reports that "Saudi Arabia is planning to lift oil output sharply in June, whatever policy OPEC adopts this week, in an effort to rein in high fuel prices. Riyadh expects to lift production by more than 500,000 barrels a day in June to its highest for three years, a senior Gulf industry official familiar with Saudi oil policy told Reuters." We can't wait to hear how Saudi's unilateral plan to boost Obama's reelection chances is met by other OPEC members such as Iran, Venezuela, Iraq and Libya. "Worried about the impact on economic growth of
inflated energy costs, Saudi will act alone if necessary to keep a lid
on prices now at $114 a barrel for benchmark Brent crude." Wait, isn't OPEC a "cartel", or a place where unilateral decisions are not allowed, for precisely this reason? Of course, at the end of the day, with recent Wikileaks disclosure that Saudi Arabia admitted it has overstated its reserves by some 300 billion barrels, or 40% of total, this latest ploy to push gasoline prices lower into the summer season will have a half life that is shorter than the SNB's FX intervention attempts.

With the market now only capable of kneejerk headline reactions which end up being immediately priced in, in the pursuit of the mythical Russell 36,000, it completely ignores the actually important news (whose interpretation has not been programmed into the algos trading the S&P) such as input costs and their derivatives, which will inevitably crush margins and lead to the same market reaction as that seen in the summer-fall 2008 transition. And since leverage on all cash flow producing assets will be at the same level as US banks circa 2008, the result will be an even worse wipe out. It has gotten so bad that US Energy Secretary Steven Chu was dragged out of his office to present his version of the "irrational exuberance" speech so pervasively ignored by the stock market until it was proven to be the only sensible thing ever uttered by the maestro. At a news conference on clean energy, Steven Chu said on Thursday high oil prices posed a threat to the global economy. "The oil producer countries and the oil consuming countries are concerned because it does have an impact on a very fragile economic recovery. There is great concern," Chu told a news conference while attending a clean energy conference. "There's ongoing discussions ... I'm not going to go into any of the details of the discussions. There is a concern about trying to stabilize prices. There is a concern about rising prices," he said." There may be a concern, but according to the president there isn't really much that can be done about said prices. The best people can do is learn to cope. Especially since there is no chance that the commodity complex will be declining any time soon: to many today's ECB decision was a potential catalyst. And instead the market took one look at the number, listen for 2 minutes to Trichet's rambling remarks and bid everything up.