With prices continuing to slip deeper into the $40s, we’re all wondering what is the game plan for the Organization of the Petroleum Exporting Countries (OPEC) and its most influential member, Saudi Arabia. Even with OPEC’s reported 90% adherence in April to their production cut promise, OPEC has failed to offset the critical oversupply in crude oil that has been plaguing US and world crude oil inventories for the last two and a half years. As a matter of fact, their compliance rate is slipping! With all of this in mind, we’re beginning to wonder if supply and demand rebalance is the real target, as OPEC says, or is there something else at play. We’ll address this and more in this week’s column.
As I am sure most of you have read, OPEC looks poised, or so says the Saudis, to increase the duration of the production cuts, which started back in January, to the end of the year. The problem is the current reduction program hasn’t yielded the desired effects on inventories, and therefore prices. So, what does OPEC need to do? Will they extend the program another six months; as is? Will they look for even deeper cuts from its membership? By the way, what’s on tap as OPEC heads into their 172nd “ordinary meeting” being held later this month? And why haven’t we heard anything about this meeting?
It has been very quiet in the weeks leading up to the May 22nd meeting in Vienna. If crude oil prices are the target for OPEC, then somebody would have already leaked the details of a proposal that would have to be circulating among members; but nothing has been seen. It makes us begin to wonder if OPEC has something different in mind that may not be beneficial to the US producer.
If OPEC isn’t driving prices in our crude oil market, who or what is? It appears obvious the US isn’t even playing the same game as OPEC. US production has increased 15 out of the last 17 weeks this year and for the last 12 consecutive weeks, taking US production from 8.77 million barrels per day, back up to 9.29 million barrels per day. That’s a pretty big jump! Seasonal driving has increased refinery demand and we are pushing, as of last week’s numbers from the Department of Energy, 17.18 million barrels through our US refineries, but that’s only back to where we were in January. Other factors must be driving our prices lower, so let’s look at the current fundamental drivers in the crude oil market and see if they tell us anything different.
The Saudis
It is also entirely possible that there are conflicting motives at play between the Saudis and the membership of OPEC. In a story on Monday, the Saudis state-owned oil corporation, ARAMCO, acquired 100% controlling interest in the Port Arthur-based Motiva refinery, which was jointly owned with Royal Dutch Shell (RDS.A), along with 24 distribution terminals in the southeast US as well; this after Aramco bought the Lyondell Refinery in September of last year. What’s up with this? I’m not one who agrees with selling assets critical to our national security to an entity that houses many of the world’s worst terrorist cells! What if the King of Saudi Arabia, the defacto head of Aramco, decides it disagrees with a US trade policy; does it now have the ability to shut down our nation’s largest oil refinery? Maybe this is why OPEC hasn’t taken further steps to cut production. They are letting the Saudis complete their capture of US continental assets and gain a dead-man’s hold on our economy, by bolstering the balance sheet of Aramco, ahead of its IPO.
In the story, to be fair, Aramco says they are just shoring-up a critical trade partner in the US and protecting their world market share; but to most, gobbling up US refinery and distribution assets constitutes nothing less than a direct threat to US security. Apparently, the lack of noise out of OPEC, in a market that thrives on noise out of OPEC, coupled with the Saudis Aramco-centric focus on capturing critical US infrastructure assets, is keeping OPEC distracted. However, there is more dragging prices down than this.
Current Energy Market Fundamentals
If OPEC and the Saudis are playing their own games, what else could be driving prices lower in the energy complex? This is a time when increased demand for summer gasoline should be driving prices up not down. As an energy economist, I read the tea leaves! In other words, I read just about every story I can get my hands on to help judge direction in the markets. This week, along with the usual stories about discontent within OPEC and lessening adherence to production cuts, but these stories have already been discounted in the market place. In other words, OPEC production cuts, real or not, are already priced into the market. So there’s something else at play.
As we look deeper into the fundamentals that are driving this week’s energy market, it is important to look at related stories that could be contributing to lower prices. Last week’s report by the Bureau of Economic Analysis (BEA) on the US “Gross Domestic Product” (GDP) and “Durable Goods Orders” are two stories that will create a drag on energy prices for the next month or so.
GDP is a macroeconomic factor that measures the monetary value or economic output for all goods and services produced in a quarter in the US. In other words, it is a lagging indicator that measures whether the engine of economic growth is revving up or slowing down. Last Friday’s GDP report from the BEA showed growth of 0.7% versus expectations of a 1.2% increase for the previous month. Even with a positive 0.7%, the US needed to see at least the 2% increase to show economists that the economy is continuing to grow. This report indicates the US economy is slowing, but not contracting.
Here is a graph showing US GDP growth rates since 1946. It shows the US economy isn’t as energized as it has been over the last 70 years!
Another contributing macroeconomic factor that is weighing on energy prices is “Durable Goods”. Durable Goods are goods that do not wear out quickly; more specifically, they are goods that last longer than three years, like automobiles, appliances, furniture, and tools. Increases or decreases in the purchase of “Durable Goods” are another lagging indicator of economic activity and can foreshadow a slowdown or an upcoming economic boom. Last month’s number came in a disappointing 0.7% growth versus expectations of a 1.3% growth. This lower number indicates the economy may not be moving at the clip we need to sustain growth in demand for crude oil and the refined products.
Here is a graph showing Durable Goods Orders over the last five years. It appears the overall trend is looking for lower and slower purchases of these goods.
Last week’s GDP report, and “Durable Goods Orders” do not indicate much growth in the economy and when there isn’t growth, demand tends to slip for products like gasoline, diesel and jet fuel. Electricity and natural gas slow as well, because factories are not in need of the additional energy resources they would require to produce more of their products to meet increasing demand.
Weakening economic drivers in the US, in the form of slower GDP growth and lower Durable Goods orders, are pointing to lower prices for crude oil and the refined products for the balance of this year. Relying on weakness in the US economy, the Saudis are using their corporate asset Aramco to capture US assets. These are the stories that are dominating the news cycles and contributing to prices falling ever-deeper into the $40 range. While consumers will surely benefit in the short term, our national security will be paying the tab; a tab that might just become too much to pay!
By Tim Snyder
Read More from Crudefunders
- Who Is OPEC and Why Do We Care?
- OPEC Appears To Be Delivering On Production Cuts, So Why Aren’t Prices Rising?
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- Crude Oil Production & Supply: Have We Made Any Actual Progress in A Year?
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- Geopolitical Risk and Its Effect on the Price of Crude Oil
- What Can We Learn from Crude Oil’s First Quarter Report Card?
- Crude Oil: What is the Future
- How Crude Oil Prices React to Geopolitics
- Prices at the Pump Are Rising: Is It Seasonal or Something Else?
- Is Ethanol Worth the Fight?
If you want more information on the energy markets and what is making prices move every day, go to our website www.crudefunders.com and scroll down to where it says “Subscribe”. There you will find our link to the daily commentary “Energy Wise”, a comprehensive piece that includes both fundamental and technical analysis of the day’s energy markets and provides you with the detail that you need. For more on Energy Economist Tim Snyder and his company, go to www.matadoreconomics.com.
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