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Price Fixing Anniversary

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Thirty-five years ago this week, against the backdrop of the Yom Kippur War, OPEC's Gulf members announced a unilateral jump in crude prices to $5.12 a barrel and breaking relationships with multi-national oil companies.

It was the first move by OPEC countries to exercise their sovereign right to determine the price of its national resources. 35 years ago OPEC assumed the power to consider and set prices unilaterally for its oil. OPEC's hard-line stance and the Arab Oil Embargo triggered the first oil price shock. OPEC has lost that power to set prices over the last few years and is facing a major oil price crisis. OPEC had little control over slowing the price spike to $147 back in July and even less control over the crash back to below $70 last week.

Instead of quick decisive action when prices get out of control they have been relying on scheduled meetings sometimes months in the future where internal politics and posturing by member nations often takes center stage rather than the real problem of balancing production and prices.

OPEC seems determined to take back control. The crash back to $70 reduced cash flow so severely that everyone is now paying rapt attention and if you can believe the news reports they are ready to take quick and decisive action once again. The fear prompting their call to action this time is the rapidly accelerating global recession prompted by the financial crisis. Demand has been falling sharply over the last eight weeks and some believe 2009 could be the first decline in demand on a global basis since 1983.

Comments out over the weekend suggests the cut they are going to enact will be much more severe than analysts thought. OPEC chief and Algerian Energy Minister Chakib Khelil said OPEC needs to consider a cut of 1.5 million barrels or even two million barrels per day. Khelil said the cut has to be substantial in order to reassert price and balance supply and demand. Khelil said OPEC wants a stable price between $70 and $90 for all of 2009. He cited several countries where oil prices must be over $70 per barrel or they could not produce oil for a profit. The marginal cost of oil has risen over the last three years to between $70-$80 per barrel. Below that level some non-OPEC countries may decide to reduce production until prices return to a profitable level. This is setting up a potential crisis where production becomes volatile depending on price and that will accentuate price volatility.

All of these moves are symptoms of peak oil although most would not believe a temporary excess in production is peak oil problem. Most peak oil theorists believe in an extended plateau where production and demand are nearly equal. As demand briefly exceeds production prices rise sharply. As prices rise demand declines sharply as we have seen over the last few months. Production suddenly exceeds supply again and prices drop sharply in response. The fall in prices, like we have seen over the last month brings back cheap gasoline, now under $3 per gallon, and consumption returns to normal growth patterns. The pattern then repeats over and over with overall demand eventually exceeding production on a permanent basis. This could take numerous cycles before the eventual permanent decline.  

Jim Brown

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