OPEC Supply Cut

This article is one of many which were out today. One theme was that it seemed odd that OPEC would cut production now, with quotes like this: “I am surprised that OPEC would reduce their output at a time when stocks are still substantially below historical norms and we are entering the high demand winter season in the northern hemisphere”, and this: “It surprises me that they were prepared to cut at these prices,” said Nigel Saperia of Swiss trading house Glencore. “I wouldn’t want to play poker with these guys.” Interesting. If a decision does not seem to make economic sense, you have to ask: does it make political sense?

Absolutely, yes. If I were the Saudis and the Iranians and Hugo Chavez and others in OPEC, I think it would be worth it to suffer some economic loss in the short term if I could bring on a recession which would finish off Bush’s chances of reelection. The Saudis in particular know that they are in the cross-hairs. Get rid of Bush, and you have a new lease on life.

OK. Yeah. This is pure speculation on my part, but it makes sense.

27 thoughts on “OPEC Supply Cut”

  1. Since we seem to be in a speculating mode, I speculate that OPEC’s production cut is a reasonable adjustment to an anticipated increase in Iraqi production. Or perhaps it’s in response to world demand that is lower than was earlier forecast. In any event I doubt that there is a conspiracy against us, and I doubt that the Saudis would be so foolish as to expect us to lighten up on them merely because Bush was defeated (they might actually expect more scrutiny in that case).
    Also, Saudi Arabia, which has huge reserves, maximizes profit at a lower price than do the other OPEC countries, so if anything the Saudis would tend to want to avoid taking any action that might spike oil prices. They need all the revenue they can get, after all.

  2. Disagree. The production cuts were entirely commensurate with the (ongoing) ramp of Iraqi production, slated, I believe, to approach 1.5mmBPD soon. When the production numbers get to 3.0mm BPD (within a few quarters) the battle for market share will be out in the open. Sub $20 a barrel results. The role of the Saudis has diminished greatly with Iraqi production now assuming the position of spoiler, AKA the “swing producer”.

  3. Lets not go overboard with opec’s influence on crude oil prices. Russia is currently pumping almost as much as Saudi Arabia and their infrastructure is a far cry from the Saudi’s. Although they are upgrading and exploring.

    Prices have been steadily falling for a couple of months from above $30 to today’s $28. Over the summer more than a few analysts were predicting prices to fall below $20 by Q2’04.

    So far the announcement to cut has not measurably impacted prices.

  4. That was quite an interesting article “another”. Definitely something people should know. If all that is true, which I have no reason to doubt as it sounds credible, then I am even more in favor of having these oil men in the white house.

  5. […]then I am even more in favor of having these oil men in the white house.

    Hmmm, will they be able to stabilize the economic situation in USA ? Depending on dollar to be the world reserve currency seems to be quite a double-edged sword. The White House should imho make the USA an economically stable country on its sole efforts, and not because of oil transactions are being done in dollars. But the way they are dealing with the situation doesn’t make me believe they’ll looking for that objective.

  6. To do that, I expect, would require bursting our bubble–ie, accepting stability on a lower level of prosperity than we currently have. Even if we had a lame-duck President who would do it, Congress wouldn’t dare–for anyone to get reelected on such a record would require a more forward-thinking, risk-averse electorate than we presently have.

    Hell, I like to think I’m an enlightened citizen, and even I have had to consciously restrain myself from thinking about the necessary war on terror in terms of my gas mileage and heating costs this winter.

  7. Regarding Anonymus’ link. Here’s an excerpt from the Milton Friedman interview at Right Wing News.

    John Hawkins: If the euro were to replace the dollar as the medium of exchange, if everyone bought and sold their goods in euros instead of dollars, would that have an impact on the US economy?

    Milton Friedman: The success of the United States will depend on how much it can produce at home, how much it can sell abroad, what it buys from abroad. It’s of less importance whether it is denominated in dollars or euros.

    John Hawkins: So in the end, that is really not going to make a big difference one way or the other…

    Milton Friedman: That’s not going to make a great deal of difference. What’s going to make the difference is the productivity of the different countries. But personally, as I say, I believe the Euroland is going to run into big difficulties. That’s because the different countries have different languages, limited mobility among them, and they’re effected differently by external events.

    I’ll agree Friedman on this one.

  8. I personnally tend to think that diversity is a gift. But I’m no Milton Friedman nor even a simple economist.

  9. Another Anonymous, diversity is indeed a gift, hence the worries of the UK about ‘ever closer European integration’, which sounds more and more like a formula for top-down standardization.

  10. I’m not so sure how having this switch could have a negligible effect on our economy. All these people have their US dollar reserves invested in US stocks and bonds and real estate. If there is a switch, that stuff needs to be sold so they can invest it in Euro capital instead. Such a selloff in multiple sectors would be catastrophic. There was an article in the atlantic a few months ago about the Sauds and in it, the author talked about how the Saudis have 2 trillion dollars invested in the United States. I would imagine it is because of this issue of petro dollars. $2 trillion is a lot of money.

  11. I really wanted to focus on this point here.

    “The success of the United States will depend on how much it can produce at home, how much it can sell abroad, what it buys from abroad.”

    It wouldn’t have much of an effect on the U.S. if such a switch occurred. It doesn’t matter what medium of exchange is used in transactions where both parties are not U.S. assets. There are plenty of reliable currencies in the world that don’t rely on petroleum transactions. China, Japan and South Korea come to mind as examples.

    Getting back to the topic. The markets didn’t react that harshly to the news of the cut.


    The NASDAQ was the worst hit with only a 1.2%. Hell, even the Volatility Index dropped. Normally, it would increase on such news. I think the market is factoring in future Iraqi production. This is just CYA for OPEC.

  12. Politically speaking, I think it’s safe to say that everyone BUT Bush has made it loud and clear they think the Saudis are worth confronting directly. He’s been keeping bad news about them quiet (the censored pages in that 9/11 report, for example), constantly affirming the US-Saudi partnership, etc. I haven’t really been following the presidential race, but I do remember some of the Democratic candidates stating their wish to stand up to Saudi Arabia.

    Bush may be saving his attention for later and just leading the House of Saud along for the near-term. But unless the hypothetical OPEC schemers believe a Democrat in the Whitehouse automatically means a smaller chance for military intervention, I think they’ve got their hopes on the wrong set of alternatives to Bush. Haven’t the Dems been making it a point to attack Bush on his close ties to the nation?

  13. Here’s what Paul Krugman had to say about that currency war conspiracy theory:

    “We get a tiny boost from petrodollars, but not much.  The real action is in purchasing power for foreign goods, and foreigners who use dollars in their own country, which is effectively an interest-free loan to the US government, which gets to print money to pay for things without increasing the money supply and causing inflation.  Neither of those things has anything to do with this war.  Nor is it likely that, as one commenter suggested, foreigners are going to decide we’re nuts and sell.  If they switch to the Euro it will be because they think it has lower currency risk than the dollar.  However, given the huge structural problems currently facing the Euro right now, about which here’s a post (http://www.janegalt.net/blog/archives/004108.html#004108), it’s unlikely that they’re going to switch until things have had a decade or so to shake out.”

    And here are Megan McArdle’s comments:

    “As for the idea that other nations are somehow going to punish us by turning to the Euro, the relative prices of the Euro and the dollar are decided by demand for savings/purchases in those currencies, not by some guy in the central bank who says “Japan will buy eight zillion euros and sell dollars today!” The decision-makers are bankers, manufacturers and traders looking to make a buck, a most heartless and unpatriotic bunch who are not, by my informal surveys of trading floors, much interested in sacrificing financially in order to give Uncle Sam a piece of their mind. The euro may supplant the dollar as the savings vehicle of choice, but not until all those financial types are satisfied that the structural rigidities which make Europe a sub-optimal currency zone are not going to rip the union apart and/or cause the central bank to start doing funny things with the currency. This probably won’t happen for a decade or so, and when it does, it will have absolutely nothing to do with Iraq.”

  14. Steve, you don’t sell $2 trillion overnight. And the very act of dumping so much money – assuming they have this much – would drive down the value of the dollar to a point where their money is worth less and less. This much money is just not liquid. And it’s owned by a lot of individuals who are more independent than you’d think anyway.

    Also, a lot of governments and central banks essentially park their reserves into the safest government bonds, and that’s US Treasury issues. See Japan, China and even the Middle Eastern nations. While all interested in blaming America for everything for their domestic audience, they park both their own money, and their reserves, in US Treasuries.

    I go back to a question I asked earlier. What is it, what feature does the euro have, or could have in the freseeable future, that a majority would want and the dollar would not, and could not have ?

    I never heard a convincing answer to that one. If anything, the euro is volatile. It went from $1.17 – an arbitrary value chosen by bureaucrats who just wanted to be bigger than the dollar – to $.85 then back to $1.17. All is 2 1/2 years. Its volatility against other currencies is also higher than the dollar’s.

    The European central bank is also a bit green, and investors are not yet sure of its competence or independence. And with 10 new members joining soon, and, eventually, the euro zone, the lousy EU economic numbers – compared to those countries outside the euro zone, like the UK, or Sweden – it’s going to be a wait-and-see period which will last quite a while.

    The dollar is the currency equivalent of the gold standard. It is much more than the US currency at this stage. You don’t change standards just because you can. At this point, it would be very costly; in fact, more than switching to the euro was to Europe. And what for ?

    The only reason this comes up is mostly due to the huge euro marketing campaign. The euro was sold as a dollar alternative. It was never explained why it would be one, or why that would be good. All that mattered was that it would a dollar competitor, and more valuable than it.

    (And of course, the notes and bills are ugly and boring as hell…Made In Brussels written all over it…But that’s just me…)

  15. The Euro has a long way to go before an objective person will want to substitute it for the reliable greenback. People who hate the United States salivate at the prospect of economic doom coming our way by a sudden rush to use the Euro. Unlikely. Most people who handle large sums of money are motivated by other things than a vague desire to harm the United States. The best thing the Euro can do for itself is prove it is reliable and stable for a few decades. Good luck.

  16. Sylvain,

    Here’s something from Stratfor’s net assessment of the global economy (June 25, 2003) which may throw some light on how the Euro rose so rapidly against the dollar a few months ago.

    “Stating that the Iraq war fundamentally redefined global power relationships is analogous to saying that a tidal wave can really ruin a beach trip. What few have noticed, however, is that the Bretton Woods structure is breaking down. Correction: it is being broken down intentionally.

    “On the European side, the French and to a lesser degree, the Germans, have concluded that the newfound U.S. militancy goes further than the deal represented by Bretton Woods allows. From their point of view, the overextension on the part of Washington frees them from Bretton Woods’ constraints, allowing them to pursue bolder policies independent of the United States. What European leaders have not yet realized is that Bretton Woods was not an inviolable framework constraining the United States, but a set of rules devised by Washington to extend its power. The United States granted deep market access in exchange for political subservience.

    “U.S. officials, however, understand this structure quite well. Washington sees the Europeans not living up to their end of the bargain and, therefore, is in the process of making it quite clear that the United States will not carry the economic burden of Bretton Woods if it cannot have the political and security benefits that go along with that responsibility. That fundamental disconnect between the European perception and the American reality is pushing Europe into a more disadvantageous position — both politically and economically — by the day.

    “The United States now has a foreign policy of total linkage: Washington either receives total cooperation (as it defines it) on the issue of terrorism (as it defines it), or the administration will fundamentally reevaluate every aspect of every relationship with the state in question. Such a policy is by nature very unilateralist, so any multilateral format — such as the Bretton Woods rules — is by default irrelevant to U.S. decision-makers.

    “Europe’s response has been to turn trade negotiations — an issue of little direct interest to the United States — cold. The American stance has been to crash the dollar, wreck European export opportunities, turn Central Europe and several Western European states against the EU core and play with currency markets to exacerbate Europe’s recession to a point that the euro is in crisis.”

  17. and here’s a bit of what they said about the OPEC cut:

    “The logic behind the cut is far more important. Despite its rhetoric, OPEC was not concerned as much with growing developed world reserve stocks or fears of a price plunge so much as it wanted to bring Iraq back into the OPEC system. The cut — coming in at 900,000 bpd — is exactly the amount Iraq exported during the first week of September. The cartel is doing nothing more than managing a founding member’s return to the global market; Iraq hasn’t been bound to OPEC quotas since it invaded Kuwait in August 1990. If OPEC does not cut production, Iraq — which boasts the world’s lowest production costs — potentially could flood the market. OPEC’s decision is necessary and realistic and will be implemented. Simply put, the organization can’t afford to drop this ball.”


    “On Sept. 26, U.S. President George W. Bush warned his “friends in OPEC” not to “do things that would hurt our (the U.S.) economy.” As rare as it is for OPEC to catch the market off-guard, it is far more rare for a U.S. president to focus so bluntly on the cartel. Bush’s statement puts Saudi Arabia — the architect and final arbiter of OPEC decisions — on notice that Washington will not judge U.S.-Saudi relations exclusively by Riyadh’s efforts against al Qaeda.”

  18. Hmm, that’s all good answers to the article I pointed. I think some of you are reading it from the wrong angle though. Even if the theory of collapsing money is false (which I doubt, if so much money is used for oil transaction), it is not relevant. What is relevant is if the White House believe in it enough to be scared of it, and if the OPEC members see it as mean to manipulate the market (the main article of this thread also show them as ruthless business men, doesn’t it ?).

    Of course, it’s a lot of speculations. But the fact that Iraq had switched currency just before the beginning of the Gulf war, is a serious tip imho (not a proof of course).

    Anyway, ideas in that article are not new (I’ve read them 4-5 month ago), and you probably discussed them before, so please excuse me for bringing back that story.

  19. Wild speculation. Saudis have pals in the White House they will not have if a Dem gets in
    Real issue: if a glut of oil, and OPEC, a cartel, cutting supplies, what do we do about Iraq joining OPEC to get involved in hurting American economy at the same time we need money from tax payeers to bail out Iraq?

  20. tm, that’s an interesting take on the situation…I also find the OPEC cut interesting from another angle. We are being told that Iraq is a mess, a disaster, that its infrastructure is collapsing. Which makes cutting exports to allegedly compensate for Iraqi oil all the more puzzling.

    Unless of course, things are going better than we think, and the Arab states are discounting that.

  21. Do some quick math on the numbers involved.

    OPEC Production: 24.5 million barrels per day = 9 billion barrels per year

    Cost of oil: $30 / barrel = $270 billion / year

    In a $10,000 billion economy, $270 billion is a lot of money, but not enough to have a catastrophic effect on the US. It may be a shock to have $270 billion less to play with each year, but it won’t be the downfall of the US if the underlying economics of the coutry are in good shape.

  22. Al, the thing is, these $270bn ripple through, and it’s $270bn that’s not spent on anything else. $270bn to keep things running as they are is just no fun. That’s a $1,000 per each man, woman and child in the US. When it goes up and down by a third, it has an effect.

  23. Let’s not forget that, if we assume other factors don’t entirely counteract an OPEC production decrease, the increased prices will, naturally, increase the incentive for OPEC members to cheat.

    OPEC cheating happens constantly, from what I’ve been able to learn about the cartel – the only reason the cartel works at all, as near as I can tell, is that the Saudis are willing to eat the difference out of their pockets by cutting their own production.

    It’ll be interesting to see how it works out. Will the Saudis decide they really need the money to keep their own boat floating? Will other members cheat too much to keep the facade up any longer? Is it all moot because of Russian and Iraqi production?

    And will that rat-bastard Chavez be run out of the country on a rail?

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