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Oil’s unlikely alliances likely unnecessary


From Monday’s Globe and Mail

ROME — When the Russians are ready to hop into bed with OPEC, you know the world’s oil exporters are in a panic about prices.

Russian President Dmitry Medvedev last week said his country is ready to “co-ordinate” but not “collude” with OPEC as the cartel considers more production cuts to end the price slide.

At a weekend OPEC meeting in Cairo, Saudi Arabia said $75 (U.S.) a barrel represented a “fair price” for oil. A decision on new OPEC production levels is to be made in two weeks.

Since July, oil has gone from a record $147 a barrel to the low $50s. Unless the price reverses direction, the Russian economy, and the ruble, are in trouble. Like Canada, Russia fancies itself a diversified economy; in reality, the C-buck and the ruble trade as petrocurrencies.

While the difference between “co-ordinate” and “collude” is one for linguists with international law degrees to figure out, the point is clear: Russia will do whatever it takes to get oil prices back up to repair its battered economy, even if it means joining forces with its main energy rival.

But you have to wonder why the Russians (and OPEC and the non-OPEC exporters, like Norway) are getting their oily shorts in a knot. Prices overshot on the way up. In the spring, they were tacking on about $10 a month. Now it looks like they’re overshooting on the way down. The case for sustained $50 oil is just as hard to make as the case for sustained $150 oil.

Oil prices could keep sliding. Institutional investors obviously helped to propel the price of oil and virtually every other commodity, from copper to wheat, on the way up.

Now the institutions are getting out and they haven’t finished unloading their positions. In jittery markets, even relatively small sales can knock prices down hard. The institutional purge could easily push oil down to $40, perhaps lower (just before the Thanksgiving holiday in the United States, January crude futures were trading at just under $54).

In market selloffs, the bearish news can easily overwhelm the bullish news. For example, in September, year-on-year U.S. oil demand was down by 2.6 million barrels a day, or 13 per cent. It was a big number and the market apparently took this as a sign that the Americans’ love affair with petroleum was over and that minor amounts of whale oil could meet their energy needs.

Largely ignored was the offsetting dose of bullish news. OPEC, which is responsible for some 40 per cent of global oil production, has reduced output by about two million barrels a day in recent months, and is almost certain to cut again in December.

Here’s another data tidbit: In October, China’s year-on-year oil imports were up 28 per cent. It was ignored because the world is fixated on China’s expected 2009 GDP growth rate of about 8.5 per cent, down from double-digit growth rates as long as anyone can remember.

With China still expanding at a speed Western economies can only dream about, you can bet it will keep sucking up every drop of available oil. But never mind; the market apparently considers China’s downgrade from a white-hot, to a hot, economy means it, like the U.S., no longer considers oil essential.

The market is shrugging off even more compelling data that $50 oil is unrealistically low.

At the current price, oil developments everywhere are being curtailed or shut down. Royal Dutch Shell last week announced it’s yanking its application to build the 100,000-barrel-a-day Carmon Creek oil sands project in northwestern Alberta. At the same time, Irving Oil said it is in no hurry to build the $8-billion (Canadian) Eider Rock oil refinery in Saint John. Construction will be stretched out over eight years instead of four. And so on, around the planet.

As new developments are being sent to the morgue, old developments are entering retirement homes. The International Energy Agency produced this sobering fact a couple of weeks ago: Production at 800 of the world’s biggest oil fields is declining by 6.7 per cent a year, a rate that is accelerating.

The falloff means that about 45 million barrels a day of new production in the next 22 years would be needed just to meet current world demand of about 87 million barrels a day. Filling the gap would get

harder every year because the IEA expects demand to rise to 106 million barrels a day by 2030.

If these findings alone were not enough to get you excited about oil again, nothing will. Bearish sentiment still rules, as Russia’s unlikely alliance with OPEC shows.

But a few bullish souls are starting to break from the pack. Barclays Capital has expanded its commodities team this year by almost 50 per cent, taking it to 300 employees, even as prices plunge. It considers the downturn a blip in a long-term commodities upswing. In a year or so, Barclays’ move might look inspired.


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