The Other Trouble With OPEC

I wrote a rather lengthy Money and Markets column for tomorrow. Here's one section that was cut out by my editor ...

A potential currency un-pegging is not the only problem with OPEC, nor even the most bullish for oil prices. The other problem is that the cartel is supposed to have spare production capacity of 2.3 million barrels per day, if you believe everything the Saudis and Kuwaitis tell you. It may be less than that … potentially a lot less.

In September, OPEC bowed to Saudi pressure and announced a production increase of 500,000 barrels a day, which takes effect Nov. 1. But the Wall Street Journal recently reported on a weekly report from Oil Movements, a British company that monitors oil-tanker traffic in an effort to get around the secrecy of major oil exporters such as Saudi Arabia and Kuwait. According to the report, OPEC shipments for the first 10 days of November appeared to be “well below the October equivalents.”

The Saudis and the Kuwaitis are the only OPEC members with any real spare capacity (and most of that is with the Saudis). You’d think with oil over $90 per barrel, they’d want to ship as much oil as possible, not less. And it sure doesn’t look like they’re gearing up for the new production quotas.

Is The Well Running Dry?

The bad news is that discovery of new fields peaked in 1965 and production has outpaced new discoveries every year since the mid 1980s. Production is falling hard in the North Sea, Mexico … and Saudi Arabia. While there is potential in Canada’s oil sands, it is longer-term and may not be nearly enough to make up the difference.

Now, the Saudis say they’re cutting back by choice. Sure, there are some who will tell you that the Saudis’ claims to “spare capacity” is just a sham to prop up the wobbly House of Saud. I’m not one of the people making those claims, because I don’t want you, dear readers, to start mailing me tin-foil hats.

And it’s true that while existing Saudi oil fields are depleting at an average rate of between 4% and 5% per year, down the road, the Saudis will be bringing new production online – big fields including Khursaniyah in the fourth quarter, Nuayyim and Shaybah next year and Khurais in 2009. Still, it’s something to think about.

Kuwait Takes The Plunge Into Heavy Oil

And while you’re at it, think about Kuwait.

Kuwait is known for the medium- to light-crude it pumps from its giant Burgan oil field. But two weeks ago, Kuwait announced plans to start production of heavy oil to meet its 2020 target of producing 4 million bpd.

Producing heavy oil is very different from light or medium oil. But Kuwait might be running out of options.

We already know that Burgan has peaked. In November 2005, Farouk Al Zanki, Chairman of state-owned Kuwait Oil, reported that the Burgan oil field production levels are running down. Burgan will now produce 1.7 million bpd for the rest of its 30 to 40 years, rather than previous estimates of 2 million bpd. In total, Kuwait currently producing around 2.6 million bpd, down from almost 3 million bpd in 1972.

And then there’s Kuwait’s reserves, which are reportedly depleting at over 5% per year. Last year, Petroleum Intelligence Weekly reported that Kuwait's oil reserves were about half what was officially reported, or 48 billion barrels, based on internal leaked reports. Kuwait denies the reports, but won’t disclose the size of its reserves for “national security reasons.”

If the Saudis and Kuwaitis can’t supply more oil, who can? Well, production is ramping up in Russia and some other suppliers. OPEC forecasts non-OPEC supply of oil (all liquids) to increase from 49.85 million bpd in the third quarter of 2007 to 52.12 million barrels per day in by the fourth quarter of next year.

In my opinion, that is unlikely to happen. Here are just SOME of the geopolitical brushfires flaring up across the oil patch …

1. Russia is increasing is oil production by 2.6% per year, but is dogged production problems.
2. Production is falling off a cliff in the North Sea – 8% or 9% a year. Britain’s oil output last year was the lowest since 1979, the first big year of North Sea production.
3. Mexico’s oil production is down 3.9% year over year. In addition, Mexico’s state-owned oil company, PEMEX, briefly shut in 600,000 barrels per day of crude due to storms. This came after one of its oil rigs lurched over in high seas, collided with another rig, and left at least 19 dead.
4. Endless unrest is disrupting supplies from Nigeria, and Sudanese rebels are attacking Chinese oil workers in that country.

Now, all these troubles sound far away, and not a real problem for Americans. The problem is it hits you every time you fill up your gas tank. But the much bigger problems are right here at home …

US Problem #1: For Want of an Energy Policy …

Clarence Cazalot Jr., president and CEO of Marathon Oil Corp., recently made a plea for a comprehensive US energy policy. He said that as worldwide demand for fossil fuels rises, the country's biggest challenge is dealing with these and other related issues underlying U.S. "energy security." Other top CEOs have spoken out on the same issue – the US needs a comprehensive energy policy.

The White House did roll out a sort-of energy policy in 2001 – designed by Vice President Dick Cheney’s secret energy task force. Even before he revealed his energy policy, he said that “conservation may be a sign of personal virtue, but it is not a sufficient basis for a sound, comprehensive energy policy.” So, it’s not surprising that the White House plan was piece-meal and seemed more focused on handing out goodies to friends in high places rather than coming up with a comprehensive plan.

That’s a shame, because no country on Earth is more vulnerable to higher oil prices than the US. We import over half our oil. More importantly, the US uses 25 barrels of oil per person per year, compared to 12 in Western Europe, two in China and one in India. Of these 25, about nine are produced domestically and 16 imported.

Conservation led to increased efficiency after the 1979 oil shock, and that’s how Americans cut oil use 15% in six years while the economy grew 16%. I think it’s something we have to try and soon.

Energy conservation is also called “negawatts,” and it’s a fact that the cheapest energy in the world is energy you don’t use. If Americans want to see oil on the down side of $50 per barrel ever again, we might want to consider making energy conservation our next national project. If we keep using energy the way we are now, all the drilling in the world won’t save us.

US Problem #2: The Falling US Dollar

We at Weiss Research have been pounding the table about the weakening US dollar for quite some time, but the decline so far may be just a bump compared to the plunge around the corner. Saying that our elected windbags in Washington spend money like drunken sailors is an insult to drunken sailors. Runway consumer debt, credit inflation and the bursting real estate bubble are compounding the problem. And now, the US economy is slowing down even as the rest of the world bustles along.

The International Monetary Fund has targeted global economic growth at over 5%, led by powerhouses including India and China. Even Europe is expected to grow at about 2.5%. But in its latest World Economic Outlook, the IMF put the US’ 2007 economic growth rate at 1.9%, and said 2008 would see the same sluggish growth.

It’s pretty bad when “old man” Europe is outpacing you. In practical terms, this means international investors are more likely to steer their funds away from the US toward other countries. And that will send oil prices higher, because oil has a negative correlation to the US dollar of over 80%.
We’re already seeing this effect on oil and the dollar. And if OPEC does move to pricing oil in a basket of currencies, as I talked about earlier, that could turn the dollar’s slide into a free-fall.

Could anything drive the price of oil lower? Well, if the US dollar bounces, that would help. Or if the US economy goes into recession, that might lower oil demand around the world enough to send prices lower. But don’t count on that for two reasons …

#1) A recession in the US would send the value of the US dollar lower as well

#2) During the first eight months of the year, China's net imports of crude oil rose 18.1% over the same period last year. In other words, if we don’t buy the oil, someone else will.

There are many other things that could affect the price of oil – a clash on the Turkey-Iraqi border, a sudden spurt in supply or more storms in the Gulf of Mexico to name three. We should see corrections to the big trend. But the big trend should remain oil prices up and the US dollar down, so those corrections should be bought.

Check out my new gold and energy blog at MoneyAndMarkets.com