March 3rd, 2011
03:15 PM GMT
Three short years ago in the first quarter of 2008, members of OPEC, especially those in the six Persian Gulf states, were riding a wave of surplus capital flowing into their coffers as oil crossed over the three digit level of $100 a barrel.
As we all know, prices continued the march to $147 that summer and started a sharp spiral downwards when the banking crisis set in, the recession took hold in the West and spread like a virus to the fast growing economies of Asia.
Is this a case of deja vu and we will witness a nasty correction as oil prices undermine fragile recoveries in the U.S. and Europe? Quite possibly yes. Contrary to some of the popular thought being shared online, the major producers in the Gulf States are not eager to see a repeat of the autumn of 2008 when prices tumbled more than $100 in six months.
What OPEC, especially Saudi Arabia which sits on a quarter of the world’s proven reserves, has been striving for is a "Goldilocks price" for crude. You remember the fairytale, the porridge that was not too hot, not too cold, but just right.
King Abdullah of Saudi Arabia actually stated what he thought Goldilocks oil was during the run up to a record price of $147 - something in the range of $85-90. OPEC countries are sitting on spare capacity of about four million barrels a day - three-quarters of that in the Kingdom. Most of that spare capacity is there because global demand still remains well below the pre-recession peak levels.
China, India and Southeast Asia have revved up growth again, but America and Europe have needed historically loose economic policies and easy money to sustain a tepid recovery. If this Middle East crisis would have hit right in the midst of the peak of global growth, one would probably be looking at a new record for crude.
While many are quick to jump on the bandwagon and ask Saudi Arabia and others to open their taps (which they are doing already) we should also keep in mind that the market is starting to price in worse case scenarios. Not only are consuming states pondering the future of Libya and its 43 billion barrel reserve, but Algeria, Egypt and Oman as well.
All four combined have production output each day of more than four million barrels. With that simple math, it is quite easy to see why OPEC’s spare capacity gets stock market investors a bit nervous. But it is difficult at this stage to ponder all four of those countries not sustaining production over the medium term.
Whoever comes into power wants the cold hard cash that their black gold generates. There are also other key forces at play in today’s “three digit market,” most notably the hedge and pension fund managers who see the commodity market as an easy bet for making money. Some of the best energy strategists that I have spoken to say that at least 10% of today’s price is driven by these funds. They say another 10% if not more represents a security risk as in the concern that supplies out of the Middle East may be hampered if the region continues to have no endgame in site for political stability in Libya, Egypt, Bahrain, Tunisia and Algeria.
In the classic version of story, Goldilocks wakes up out of a deep sleep, sees the three bears and scampers out of the cottage where she is an unwelcome visitor. The return of the “Goldilocks scenario” to the energy market would certainly be welcomed by producing and consuming nations. They are fearful of the impact today’s $100 oil will have in the near term - but this looks as elusive as the character in the fairytale.
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