Today's Analysis: Showdown at the OPEC Corral

OPEC is in the midst of a major showdown with regards to production quotas. On one side is the U.S. friendly cartel leader Saudi Arabia, while on the other is the increasingly anti U.S. and pro Cuba Venezuela. At stake could be the balance of power in OPEC, and a redefining of major producer/consumer relationships in the world of the oil markets.

The chatter before the June 15 OPEC meeting is already near fever pitch. Venezuela wants to keep prices higher, and is pushing for production cuts. Saudi Arabia wants to make no changes in production.

According to Bloomberg, Venezuela's oil minister Rafael Ramirez, in remarks to reporters on May 18, noted that "OPEC should evaluate a cut in oil output this quarter and guard against any sudden drop in prices." According to Ramirez "The world has ample supplies of oil and no extra production is needed." Readers of this space, and our recent article in CBS Marketwatch "Running on Empty" are aware of the situation in Venezuela, where reports from credible sources have built a case to suggest that Venezuela's production levels are significantly below the official government figures of 3.2 million barrels per day.

Bloomberg also quoted OPEC president Sheikh Ahmad Fahd al-Sabah, Kuwait's oil minister, in an interview in Jordan, where he is attending the World Economic Forum as having said that "OPEC, the supplier of almost 40 percent of the world's oil, will keep production near record levels to meet global demand regardless of whether it causes crude prices to fall further."

Yet, according to Reuters "Many OPEC and other oil producers believe an oil price range between $30 and $50 a barrel could be suitable for both producers and consumers. The very busy OPEC President Sheikh Ahmad al-Fahd al-Sabah, on Sunday, "told Dubai-based Al Arabiya TV in an interview that additional crude oil output from a stable Iraq and new investment by OPEC and other producer nations to boost their production capacities could help ease global market worries over supplies."

Al-Sabah, in fact seems to be floating a new price range trial balloon. ["These are not prices as they once were -- $9 or $8, but also not $100 or $200," he said. "I think, now, there is a median that many of the OPEC members and producer nations are talking about, which is a range between $30 and $50."]

In fact, despite Venezuela's vocal opposition "On Friday, the OPEC president told Reuters the cartel would continue pumping in excess of its own official output limits, at about 30.5 million barrels per day (bpd), allowing stocks to build further on a comfortably supplied world market."

As it stands right now, according to Reuters: "OPEC is producing about a million barrels daily above its official 27.5 million bpd output target, with another 2 million bpd from Iraq not included in quota arrangements. Sheikh Ahmad said this volume of over-production would help bring prices down to $40-$45 per barrel."

And there is still spare capacity in the system as it currently stands, if you count Iraq, which current OPEC quota figures are not. "Sheikh Ahmad said that according to the latest figures, Iraq has a capacity to produce up to 1 million barrels per day above the 2 million bpd it has been producing on average since the start of this year. Iraq can reach total output of 4 million bpd to 5 million bpd in the future with more investments in its upstream sector, he said.


This may be the usual pre-OPEC meeting posturing. Typically, the hawks start pushing for price hikes and production cut backs in order to keep the doves from rolling over them.

The key is what the comments are doing to the markets. And so far, it looks as if the doves are getting the best of the price action, at least in the early going. The meeting is still some three weeks away, on June 15. So there is plenty of time for both sides to jawbone the issue, and for much to happen along the way.

What is really going on, though, is that OPEC has a major rift in its ranks.

On one side is Saudi Arabia, and apparently Kuwait. Both of these countries have a security debt to the United States, and also share Iraq as a point of contention. The Saudis did not want the U.S. to invade Iraq in 2003, while Kuwait was glad the U.S. invaded Iraq in 1991.

Recently, as we pointed out here, Saudi Crown Price Abdullah and U.S. President George Bush, seem to have agreed on some kind of broad outline used to strengthen the until recently strained relationship between Saudi Arabia and the U.S., in the post 9/11 period.

On May 19, in this space we made several points with regard to the newly re-energized relationship between the Saudi kingdom and the White House:

1) According to Reuters "The United States has quietly dropped a year-old warning it issued to its citizens to leave Saudi Arabia, but says they should still avoid travel to the kingdom because of possible militant attacks."

2) The coordinated effort by the Saudis to talk down the price of oil, "also coincides with high profile visits to the United States by Oil Minister Ali al-Naimi and a Saudi trade delegation which has been touring the United States to encourage investment in the pro-Western kingdom."

3) Indeed, there are very large sums of money and significant political changes afoot. According to Bloomberg, Saudi Arabia, "is inviting Exxon Mobil Corp and other US companies to invest in more than $1.4 trillion of natural gas, chemical and other business in a bid to create more jobs, the government said. " Much of the work has been quietly, but not secretly been ongoing for some time, as "A 50-strong delegation from Saudi Aramco, Saudi Basic Industries Corp and other Saudi organizations are touring the US speaking to companies about investment opportunities in the kingdom, including $140 billion in infrastructure projects and the sale to the public of up to $800 billion worth of shares in state-owned companies, the official Saudi Press Agency said on Monday, citing Khaled Al-Seif, head of the delegation. "

We concluded, on 5-19: "This is part of a much larger, and very long term strategy, which focuses on the business side, on the Saudi kingdom's bid to enter the World Trade Organization, which received public support from President Bush at the Crawford meeting, and includes key concessions from the Saudis, including allowing foreign investors to own up to 60 percent of shares in local banks by the end of the year. Currently, foreign investors can own up to 49 percent of capital in Saudi banks. As reported by the Arabic business daily, al-Eqtisadiah, ["Saudi Arabia has 11 banks, 7 of which are partially owned by foreign investors."] The plan also involves the selling of public stakes in Saudi companies. According to Bloomberg: "Saudi Arabia may offer to the public as much as a 40% stake in National Commercial Bank, the kingdom's largest lender, this year, the Riyadh-based Arab News has reported."

What makes the situation between Saudi Arabia and Venezuela interesting, is not where it differs, with regard to the U.S., where the former is getting closer and the latter is increasingly distancing itself, but in the similarities.

Both are major oil producers. Both are members of the ruling OPEC cartel. Both have embarked on ambitious wealth redistribution and social safety net programs lately, with the Saudis increasing theirs after 9/11, in hopes of quelling the formation and expansion of Al-Qaeda and similar types of militant organizations. And both are dependent on oil as their major source of financing for running their respective countries.

The difference, and an increasingly stark one, is in the way that both countries are moving with regard to the U.S.

Unless something changes, it looks as if over the next few months to years, Venezuela is going to attempt to significantly curtail its oil shipments to the U.S., as the Saudis increase theirs. Whether this is feasible or not is as important a question as any. That it will be attempted is almost certain, given the escalation of Venezuelan president Chavez' rhetoric toward the U.S., with his most recent pronouncement being that he is considering an "evaluation" of whether the U.S. and Venezuela need to have embassies in each other's capital.

Venezuela is a key provider of oil to the U.S. The geographical logistics of delivery are much easier than from the Saudi kingdom, a half a world away, and key U.S. companies, such as Exxon Mobil and Chevron Texaco have key facilities and major projects ongoing in Venezuela.

Further difficulties with Venezuela, in our opinion, have the potential of adding a nearly permanent surtax to every gallon of gas pumped in the United States.

Finally, the effects of a major rift in OPEC, or even the expulsion, or voluntary resignation of a member, such as Venezuela, for which there is no proof of at this point, could set in motion a whole new set of repercussions in the oil markets.

Oil Market Summary And Outlook: New Price Range From OPEC

OPEC's president is floating about the idea that a price range between $30 and $50 would be a good compromise for both producers and consumers. And the markets are thinking about it, as prices continued to slip in overnight trading.

Despite all the talk of record output from Saudi Arabia, oil prices remained above $47 in pre U.S. trading, although the June contract closed below the key 200 day moving average support level on Friday.

This could be the week that makes or breaks prices over the next few months, which means that the oil supply report on Wednesday will be as watched a set of statistics as any in the upcoming calendar.

U.S. oil supplies are some 14% higher than they were a year earlier, and there are signs of a slowing economy and the potential for decreasing demand, a continued set of pressures on prices.

Still, as we have noted lately, the oil markets are volatile by nature. And there is no certainty, other than the market will fluctuate. The big picture in oil remains technical, with the key are remaining the 200 day moving average, which is near $47, and near which crude futures for June are now trading. Further out, in September and December, the futures are still trading at higher prices, suggesting that over the longer term, the market is still betting on higher prices.

The 200 day line is not a perfect indicator. Indeed, what we expect is a lot of bouncing around near this level for at least a few days. We could even see a snap back rally from the area that could be very convincing and could take prices back above $50. If there is such a rally, though, the most important thing is to see how it resolves.

A sustained break below the 200 day moving average in June, though, could take oil prices to $40, the middle of OPEC's newly minted $30-$50 price range.

History shows that oil moves on supply, not demand. And supply, as of last week was at 10% above the levels at the same time in 2004, the major factor upon which the markets seized to accelerate the recent down trend.

Still, until the 200 day moving averages on futures contracts get taken out convincingly, we remain in a long term up trend in oil, and in our opinion, we are not very likely to see oil below $40 per barrel for some time, unless something very dramatic happens, such as a collapse of the Chinese economy, which as we've stated numerous times (see our archived IQ reports) is a plausible scenario.

Investors should remain wary of the oil market, and should use extreme caution in any exposure there. Aggressive traders should be looking to go both short and long at this point depending on the individual circumstances of each position.

The Philadelphia Oil Service Index (OSX) continued to struggle, and again closed below the 130 area, again stopping just at its key 200 day moving average. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) stopped falling, but could be headed to the 740 area, its 200 day moving average, although a bounce is possible.

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