OPEC

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.

Remember how OPEC promised it would immediately expand its "millions" in barrels in "excess capacity" when Brent passes $120? We are expecting a PR from Saudi Arabia it promises to releases it gobs of strategic reserves any...... minute.....now.......now.........NOW damn it. And to all our European readers, we offer our condolences for $10/gallon gas. Take it up with the Chairsatan... oh wait, the San Fran Fed just issued a paper saying the Fed is not, repeat not, responsible for $121 Brent. And the San Fran Fed is always, repeat always, correct. Oh well, it's all that perfectly inelastic demand for gas at surging prices then. Sorry.

And some more bullish news for inverse consumption from JPM's Lawrence Engles Daily Note On Oil: 'As long as key economies remain on track, and given the tensions still manifest on the supply side, we remain positive on near-term price outlook and expect 2Q2011 Brent crude to average $118/bbl, prices possibly spiking towards $130/bbl, if OPEC fails act in time and raise production." Basically we are no recreating the "goldilocks" economy from late 2007/early 2008 when everyone thought crude at $150 was sustainable. And back then there wasn't quite as much "speculative actions driven by too much liquidity" as noted earlier by Charles Plosser.

Even as gas continues to creep ever higher, removing substantial marginal purchasing capacity from the US consumer, a topic beaten to death previously, the oil exporting cartel remembers that in a world strapped for energy, oil prices can and will be quite sticky. Which is why now that OPEC has had its refreshed taste for $120 brent after a three year hiatus, it will most certainly not let the price of crude drop into double digit territory absent another massive deflationary shock a la the fall of 2008. To wit, OPEC has just announced that $120 oil is an acceptable level and will "not hinder global growth." Funny - if one pulls OPEC press releases from the summer of 2008, the cartel used verbatim words to describe $150 oil, and its impact on the world economy. Then again, as Dallas Fed's Fisher pointed out earlier today, commodities are now exposed to the same excess liquidity bubble that took crude to its all time highs. We expect nothing less this time around, especially now that for some inexplicable reason, the world believes that the Fukushima situation is contained and thus the "demand destruction" part of the equation can fall out.

Goldman's David Greely released a crude update factoring in the Libyan revolution in his latest estimates. As it hit the tape ahead of the force majeure announcement later in the date, the predictions in it are especially relevant as pertain to future crude price dynamics. Specifically: "We expect Libya’s crude oil production to reach 1.6 million b/d in 2011, 1.8% of global supply. Should this production be lost to the market, it would require over half of OPEC’s spare capacity to replace. This would dramatically pull forward the return to a structural bull market that we saw occurring in 2011H2 and 2012. Already, the spread of political instability to Libya has sent Brent prices to a post-financial crisis high, close to our 12- month target. The continuing spread of protests through North Africa and the Middle East presents a clear upside risk to our forecasts." And while the focus on Goldman's report is on the spread between WTI and Crude, a topic beaten to death previously, and where the firm sees it going, the more important observation is Goldman's updated price forecasts for Crude and WTI. There are as follows: "We are lowering our WTI-Brent spread forecast to -$5.50/bbl, -$4.50/bbl, and -$3.50/bbl on a 3, 6 and 12-month horizon. This lowers our WTI price forecasts to $97.50/bbl, $100.50/bbl and $103.00/bbl and raises our Brent forecasts to $103.00/bbl, $105.00/bbl, and $106.50/bbl on those horizons." For those who are confused by the disconnect between the first part of this Goldman's argument (price surge on Libya), and the second (WTI price drop due to a spread compression), you are not alone.

Today's rumor mill will apparently focus on whether OPEC will or will not miraculously push the "gush" button. After earlier we reported rumors that OPEC would raise oil supplies, and quoted the Kuwait oil minister, now the Saudi oil minister was caught on tape saying there will NOT be an extraordinary meeting. Which means that the Italian guy was spreading false rumors. Which means that whatever the offer for Italian CDS is, it is cheap. WTI, naturally, rallies on the news.

Those following the move in WTI this morning may wonder what the catalyst for the ongoing retracement has been. According to Italian sources (the country most affected by developments in Libya so take it with a grain of salt), OPEC is meeting in Riyadh to evaluate hiking crude supply in light of Libyan developments. This mirrors a less definitive statement issued earlier by the Kuwait oil minister that "OPEC could call an emergency meeting if required by disruption to oil supply due to Middle East unrest." As a reminder after peaking WTI at $98.25, it since pared gains to under $95.75, and was trading at $96.11 last. So while Bernie Bernanke can always print dollars, it is up to OPEC to print oil. And the market seems to be satisfied for now with promises of such.

As oil sees its image tarnished from the disastrous oil spills that took place off the coast of the Gulf of Mexico and off the coast of Dalian, China, and as the most promising oil fields remain off limit to the Western oil majors, gas is gaining in popularity. Gas is present in large quantities and in many countries of less questionable reputation such as in the United States and is also less harmful to the environment than oil. Though gas is not intended to replace oil, some gas-rich countries such as Russia and Iran are strongly advocating for a gas cartel to regulate the industry, which can explain the reluctance of Russia to adopt sanctions towards Iran at the United Nations as both countries heavily rely on the income generated by their natural resources.