As the recent summit of the Organization of the Petroleum Exporting Countries (OPEC) suggests, the ceiling for oil production will not be lowered, despite great overcapacity.
What we are witnessing is not ja cyclical shift but a new secular trend that heralds the demise of the petro-dollar era in the Middle East.
After the 1945 Yalta Conference, which effectively divided Europe, President Franklin D. Roosevelt’s subsequent meeting with Saudi King Abdel Aziz Ibn Saud led to a secret agreement, which required Washington to provide Saudi Arabia military security in exchange for secure access to oil supply.
That partnership was shaken in October 1973 by the OPEC’s oil embargo after the onset of the Yom Kippur War.
As the consequent tension led to fear that the dollar would become insignificant in the oil trade, President Richard Nixon negotiated a deal in which Saudi Arabia would denominate all future oil sales in US dollars in exchange for arms and protection from the US.
As other OPEC countries subsequently agreed to similar deals, global demand for US dollars was assured.
However, since these dollars did not become part of the normal money supply, they were called petro-dollars.
After hovering close to US$150 per barrel, oil prices plunged to US$45 during the global crisis.
With stimulus packages and recovery policies, Brent crude prices returned to almost US$130 by early 2011 but fell again to US$110 in the next two years.
These changes were fueled by the US shale revolution, slowing demand from China and other large emerging economies, rising costs of gas in several Asian economies that have been phasing out fuel subsidies and particularly the rising dollar, which contributed to the halved oil prices in the fall of 2014.
The energy producers’ rivalry for market share erupted in the OPEC summit a year ago.
As Saudi Arabia did not cut production on its own, oil prices plunged to the sub-US$50 per barrel territory.
Only a month ago, the International Energy Agency reported that more cheap oil could cause OPEC revenue to plunge to US$550 billion from the US$1 trillion average in the past five years
As a result, cash-strapped energy producers, including Venezuela, Ecuador and Algeria, lobbied Saudi Arabia to cut production in the recent OPEC summit in Vienna.
The group accounts for about 40 percent of output worldwide.
Iran said OPEC should reduce production to make room for its return to the market.
Officially, the group’s production ceiling is 30 million barrels a day. In practice, it has been more than 32 million a day in the past 18 month.
As sanctions will be lifted, Iran will generate an additional 500,000 barrels a day. Indonesia, which left OPEC in 2008, has returned and seeks to pump some 800,000 barrels a day.
Without participation by big producers outside OPEC, Saudi Arabia will not engage in production cuts.
Riyadh believes that a sharp oil price recovery could revive some US shale production, which would displace OPEC crude.
Before the summit, Brent crude closed at US$43, the lowest since 2009 amid the global crisis.
While some analysts expect a year-end rally to push the price climb to US$55-US$60 in the short-term, skeptics anticipate further price deterioration in 2016.
That will harm oil exporters but support large importers including China.
But there’s more ahead. The US dollar and oil have an inverse relationship.
When the dollar goes up, oil tends to come down. Moreover, oil is denominated in US dollar, which is intertwined with the Fed’s policy rate.
While emerging market currencies recently slumped to 15-year lows, Janet Yellen’s Fed is preparing to hike interest rates.
That is bound to increase turbulence in emerging and developing economies, particularly in those that depend on oil exports – from the Middle East and Africa to Asia and the Americas.
For more of Dr. Dan Steinbock’s articles, see http://www.differencegroup.net
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