“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice.”
-Adam Smith
Most economics textbooks define a cartel as a group of “firms” cooperating to control price or exclude entry into a market. Typically, a cartel occurs in an oligopolistic industry in which the number of sellers is concentrated and the products being produced are commodities. These cartels implement their strategies by fixing the price, managing output and/or controlling market share.
Studies have shown that over the last 200 years, cartels have been able to implement price increases of some 25% versus what the natural market would dictate. There have been a number of notable cartels in recent economic history:
- The International Match Corporation;
- The Phoebus Cartel, which was a cartel among Phillips, GE and others to control lightbulb prices;
- The International Copper Cartel; and
- Perhaps most famously De Beers diamonds who controlled some 90% of the world diamond market for a long period of time.
There are of course many others, but we would be most remiss if we forgot to mention the Organization of Petroleum Exporting Countries. This 14 member Cartel currently controls about 1/3 of the world’s oil production.
Historically, OPEC has had periods of being very effective at manipulating global oil prices. The most noteworthy example was October 1973 when OPEC implemented significant production cuts and an embargo against nations that supported Israel in the Yom Kippur war. The result was a sharp rise in oil prices that created global economic mayhem, including: gas rationing in the U.S., shortened work weeks in the U.K., and bans of non-essential driving.
So, what about OPEC today? Can they finally implement the long discussed production limits?
Back to the Global Macro Grind…
With oil up close to 8% this morning, the market certainly seems to be pricing in the likelihood of a production cut or strong agreement of some form. Our Energy Policy Analyst Joe McMonigle, who is currently at the meeting in Vienna, has a more negative view based on his research. As of early this morning his view is as follows:
“After a gloomy atmosphere last night, every OPEC minister except for newbie Indonesia said they were confident there “will” be a “deal.”
Oil prices are up big on the prospects for a deal but the details will be important. Remember the Algiers “deal” was really only an agreement to agree. Then there’s compliance of a deal that Saudi Arabia seems to be alone in stressing. Finally, Russia’s alleged promise to cut production, and not simply freeze, appears to be the big game changer this morning for prospects for any deal. But in our view, Russia’s compliance is the weakest link.
SAUDI ARABIA: Saudi Arabia’s oil minister said today he was hopeful there would be a deal but tried to adjust expectations by adding that even if there is no deal, the market will come into balance in due time. Saudi’s requirements are: Iran freeze ok but only with big Russia cut. Other OPEC members must participate except for Libya and Nigeria. Note: no Iraq exemption. The Saudi’s say there must be an effective compliance and enforcement mechanism by the OPEC secretariat and that would be key topic of discussion in the meeting.
IRAN: Iran’s oil minister maintains they will not freeze but will accept another “arrangement.” A freeze is politically unacceptable to Iran so they will try to sell it as something else. Iran wants to freeze at a pre-sanctions level. The Saudi's want something lower but will agree to a number in between. According to Saudi Arabia, the pre-sanctions level must be based on secondary sources but Minister Al-Falih would not give a specific number. Bloomberg is reporting the number is 3.9 Mbd.
IRAQ: Iraq said it will agree to cut but the number needs to be defined.
RUSSIA: The big change today from yesterday is that Russia has agreed to cut production, according to the Iranian Minister. The Iranians credit Monday’s phone call between Presidents Rouhani and Putin. The Saudi Minister acknowledged the Russian commitment but said he would leave it to Russian Minister Novak to describe its participation in the non-OPEC cut.
If true, this would be a big reversal for Russia which has maintained that it would only freeze production at current high levels. OPEC would like the non-OPEC cut to be about 600,000 bd of which Russia would have to commit to about 400,000 bd.
Significantly, for Saudi Arabia, the Russian participation is not a wait-and-see development but rather a prerequisite for their approval of the deal. If there is a deal, Russia’s follow through on its commitment will be the weak link in our view.
BIG NUMBERS: Saudi Oil Minister Al-Falih suggested the collective OPEC cut would be 1.4 Mbd and non-OPEC 600,000 BD. Others put the OPEC cut number at 1.1 or 1.2 Mbd. But note there is no limit on Nigeria or Libya production.
6-MONTH TERM: The length of any deal seems to be a paltry 6 months with Saudis pushing for another 6 month renewal.”
As always, the devil is in the details and despite the record levels of long oil bets going into this OPEC meeting, the reality may be more in line with this quote from Shakespeare’s comedy “Much Ado About Nothing”:
“Sigh no more, ladies, sigh no more,
Men were deceivers ever,-
One foot in sea and one on shore,
To one thing constant never.”
A short term agreement with vague and unenforceable targets won’t keep oil elevated for long. Email and let us know if you’d like Joe to call you after the OPEC meetings are completed in Vienna.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.09-2.41%
SPX 2170-2220
VIX 11.90-15.59
EUR/USD 1.05-1.07
Oil (WTI) 43.03-48.90
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
