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Oil and Financial Crisis

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The multi-trillion dollar coordinated government bailout of the world's banking system boosted equity and oil prices for less than two days before a three-day plunge sent oil to $68 a barrel for the first time in 16 months. The $15 drop was enough to spur OPEC to move up its emergency meeting from after the US elections in mid-November to this coming Friday. The drop was precipitated by a drop in equity markets and an unexpected jump in US stockpiles.

A rebound in the stock markets on Thursday combined with the prospect that OPEC will soon be cutting production resulted in oil prices climbing on Friday to close out the week at $71.85 a barrel.

The weekly US stocks report showed US gasoline and distillate refining coming back from the hurricanes and, combined with very large gasoline imports, resulted in US gasoline stocks increasing by 7 million barrels. Total US oil consumption over the last four weeks was down by nearly 9 percent from last year although some of this drop was due to the disruptions caused by the hurricanes. US gasoline consumption during the last four weeks was only down by 5.2 percent. As average US gasoline prices have now fallen by $1.12 a gallon since July, it will be interesting to see if gasoline consumption increases again during the next few weeks.

Preliminary reports show OPEC exports dropping anywhere from 350,000 to 600,000 b/d during September. Platts reports increasing signs that crude and products are becoming more difficult to sell on the world market, suggesting that an oversupply is developing.

The nearly 50 percent drop in oil prices during the last three months has been for the most part attributed to the belief that the recession will eventually lead to major reduction in demand for oil products. Some have blamed the decline on speculators being forced out of the markets, however, last week new reports suggest that additional factors may be involved. One report concludes that investors pulled $210 billion out of US hedge funds during the third quarter forcing the funds to dump assets, including oil, thereby forcing down prices.

Another new factor is the credit crisis which has reduced the availability of credit to oil traders and shippers all along the supply chain from the oil producers' ports to the consumers. This has resulted in a drop in demand for oil by traders who can no longer get financing and has left the market largely in the hands of the major oil companies and very large retailers, such as WalMart, who have the size and liquidity to force prices lower. Lines of credit are being reduced to smaller traders and letters of credit that guarantee oil shipments are becoming difficult to obtain.

While in the short term the lack of freely available credit may be forcing prices down, it will not be long before the situation forces production cutbacks, shortages, and eventually higher prices.

The OPEC Production Cut

All eyes will be focused on the OPEC meeting that takes place in Vienna this Friday. With prices falling another $10 last week, some form of cut seems inevitable. At an average of $68 a barrel for OPEC crude prices are now below the level required to permit Venezuela and Nigeria to continue spending at current rates and are getting within $10-15 of what the Saudis, Iran and

the UAE need. Caracas of course wants the Saudis and the smaller Gulf States to absorb whatever cuts are necessary to force oil back to $90-100 leaving the more populous states - Iran, Nigeria, and Venezuela - with the income to support current programs.

The financial world, however, has changed markedly. With a global recession looming and an all-to-real credit crisis threatening economic activity, it just might not be possible for the OPEC states to increase their income at the expense of others as it did two years ago during the last production cut. Many believe that forcing oil to higher levels will ultimately lead to inflation and worsen the situation.

To their credit, most OPEC members are currently talking about "stabilizing" oil prices in the $70 to $90 range. The key question is whether or not they have to power to do this in the midst of a global recession. Some analysts are already talking about oil falling to $50 or even $35 a barrel if the economic situation worsens. Some foresee the cost of exploring for and producing new oil dropping if the recession deepens; others are not so sure.

If it is clear that there is an oversupply, the Saudis will have no trouble cutting production especially as oil is currently selling for less that half of what it was last July. How much of a cut will be made on Friday, and more particularly who agrees to accept and actually sell less oil, will be interesting to watch. Currently a cut of 1-3 million b/d are being mentioned by various oil ministers, but as usual the Saudis are mum. If credit does not free up shortly, further cuts may be necessary to reverse what is sure to be further price drops. It certainly seems that world oil production is going move lower, perhaps much lower, in the near future.

Excerpt from Peak Oil Review

Tom Whipple, Steve Andrews

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