What’s Behind the Crash in Crude Oil?
By Gary Dorsch, Editor – Global Money Trends newsletter
Is it enough to point the finger of blame for the latest crash in crude oil on the arrival of global warming? Unusually warm weather in Russia, Europe, and the United States, with temperatures reaching the upper 60’s in New York’s financial district, weakened global demand for heating oil by 23% below normal last week, and a 30% drop in heating oil demand is also expected in the days ahead.
Quite often, markets seem designed to fool most people most of the time. Global economic growth and oil demand growth are usually linked, so given expectations for global GDP growth of 4.4% in 2007, it’s logical to expect global demand for crude oil to increase by at least 1.2 million barrels per day (bpd) this year. However, that would fall short of 1.8 million bpd of new oil supplies that OPEC expects to come on stream from Angola, Brazil, Canada, Kazakhstan, and Russia this year.
Non-OPEC oil output rose to 51.7 million barrels in the fourth quarter, or 3% higher than a year earlier. OPEC-10 said it would address the net increase in global oil supply in 2007, by lowering its oil output by 1.2 million barrels per day (bpd) to 26.3 million bpd in November, and then lower oil output again in February by an additional 500,000 bpd to 25.8 mil bpd. “OPEC’s reduction of 500,000 bpd has been scheduled to come into effect during the winter demand period, while addressing looming market imbalances for 2007,” the cartel said on December 14th.
On January 5th, US crude oil prices had already plunged 10% over three days and touched a low of $55 per barrel, on news available to insiders, but not yet known by the public at large. OPEC was cheating on its pledge to cut its oil production to 26.3 million bpd in December. Instead, the cartel pumped 27 million bpd or 700,000 bpd above it’s agreed upon quotas.
Ironically, the two biggest cheaters in OPEC were the two most vociferous price hawks, Iran and Venezuela. After pledging to cut its oil output by 176,000 bpd in December, Tehran left its oil output unchanged at 3.83 million bpd, while Caracas actually increased its oil output by 20,000 bpd last month, after pledging to reduce output by 138,000 bpd. Riyadh cheated by 80,000 bpd last month. It’s hard to believe OPEC will meet its pledge to cut oil output by 500,000 bpd in February, when the December agreements have not been fully kept.
However, the sudden plunge in crude oil prices to $55 per barrel, was all the more puzzling, when one considers that US commercial oil stocks had fallen from 341.1 million barrels on November 17th, to as low as 319.7 million barrel last week. The sharp drop in US oil supplies suggested that OPEC was honoring its pledge to cut output 4.3% in November, and to defend US oil prices at $60 per barrel.
While the media focused on the balmy weather to explain the sudden 10% plunge of crude oil to as low as $55 /barrel on January 5th, what initially triggered the drop was a surprise move by Saudi Arabia to slash the price of Arabian Light, its finest blend, by $1.75 /barrel to a $7.50 /barrel discount to West Texas Sweet, for its US customers, the deepest discount in 10-months.
Saudi Arabia also cut the price of Arab Light to Asian buyers by a more modest 10 cents and to European buyers by 20 cents from January. About half of the Saudi kingdom’s 7 million bpd of crude exports move to Asia. But why did Riyadh to decide to tip the delicate balance between fear and greed in the oil markets to the bearish camp, by slashing its US oil price by $1.75 /barrel on Jan 2nd?
Persian Gulf oil ministers have carefully avoided mentioning a target price for their oil, but Kuwaiti Energy Ministry Undersecretary Issa al-Oun said on Nov 14th, “The Gulf Cooperation Council states see oil prices between $55 and $60 a barrel as an acceptable level, but if they start to decline then there should be action.” What is not known is whether al-Qun was referring to OPEC’s reference crude basket price, which closed at $51.25 on Friday, or West Texas Sweet which trades at a higher price.
Russian Bear Shuns OPEC, Pumps record barrels of Oil
So far, Russian kingpin Vladimir Putin hasn’t joined the OPEC cartel in cutting oil production, and instead, is pumping oil at full speed. Putin’s lack of cooperation on oil production is creating bitterness within the ranks of OPEC, and might explain why most members of the cartel are cheating on their quotas. Oil production in Russia increased 2.1% year-on-year to a near record 9.75 million bpd in December.
The last time Russia cooperated with OPEC to shore up oil prices was in December 2001, when US crude oil prices were trading at $18 per barrel. At that time, Moscow cut its output by 150,000 bpd, Mexico cut 100,000 bpd, Norway cut 200,000 bpd, and Oman cut its output by 40,000 bpd. OPEC slashed its output by a hefty 1.4 million bpd. So far, there is no such joint initiative on the table for 2007.
Largely due to booming crude oil and base metal prices, Russia's foreign trade surplus rose to $140.1 billion in the first ten months of 2006 from $117.2 billion in the same period a year ago. Oil accounted for 35.2% of Russia’s exports in the first 10 months of 2006. Russia also derives 15% of its export revenues from metals, such as iron and steel exports which earned $22.5 billion, and non-ferrous metal exports of $16.5 billion in 2006. Russia is the world’s fourth-largest steel maker, and the world’s top nickel and second-largest aluminum producer.
In Rotterdam, Russian Urals crude oil fell below $50 per barrel for the first time in eighteen months, and should slow the Kremlin’s massive build-up of foreign currency reserves, which hit a record $299.2 billion in December. Russia has the world's largest foreign reserves outside of Asia, and its holdings have grown by more than 50% from a year ago on the back of higher base metal, gold, and crude oil prices. Earlier this year Russia said the share of US dollars in its FX reserves had been cut to 50% and that of Euros increased to 40%, with the rest in yen and sterling.
Booming exports helped Russia’s economy expand by 7.3% in November from a year earlier, and 6.8% higher over the first 11 months of 2006. To fuel its booming economy, Moscow is diverting more of its oil production to meet domestic needs and exporting less outside of the CIS. Oil exports to countries outside the CIS fell to 4.16 million bpd in December, or 12% below the peak in June of 4.76 mil bpd.
With Russian oil exports outside the CIS declining for the past six months, the recent growth of Russia’s FX reserves is mainly linked to the appreciation of the Euro against the weakening dollar, said Russia’s central bank deputy Chairman Alexei Ulyukayev on Nov 30th. In October, Ulyukayev said the central bank had started to buy Japanese yen for its reserves, and also mentioned the Australian and Canadian dollars and the Swiss franc as possible candidates for future purchase.
Russia’s oil pipeline monopoly Transneft handles around 1.5 million barrels per day or a third of Russia’s exports, but was losing money due to the appreciation of the rouble against the dollar. But on Dec 1st, Moscow approved a request by Transneft to allow it to switch to roubles from US dollars when charging shipping fees toward Russia’s largest oil port of Primorsk and loading fees in the port.
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By Gary Dorsch, Editor – Global Money Trends newsletter
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Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.
As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.
He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.
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January 19th, 2018
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