At $50/barrel oil OPEC countries go on a cat food diet. Why no whining this time around?

Crude oil markets, which normally just bore or irritate people, are actually in a fascinating (relatively speaking) equilibrium these days. It’s like the quiet moment in a room before everyone jumps out and yells ‘surprise’, or the interval at an amusement park between a flash of lightning and the boom that sends everyone scurrying like flaming rats. OPEC is up to something, and when it blows up it will be big, but no one knows quite how or when.

For the past few decades, OPEC (meaning primarily Saudi Arabia, the lord of those flies) has pretty much controlled oil prices, either through direct deeds (such as lowering oil production) or making belligerent threats which often amounted to the same thing since the media goes nuts over stuff like that, making a story whether the threat is real or potential. For a few years, relative peace has reigned as oil prices have been high but steady. OPEC was on record as saying that a fair price for oil was $100/barrel, which is as comically random as walking into your boss’s office and explaining that a fair salary would be about $2 million a year. Except OPEC gets away with it.

Last fall, Saudi Arabia did an about face and said they no longer cared about prices, and would be cranking up production to defend market share. In the past, such a statement would have brought immediate howls of protest and banging of pots from the other OPEC members, who are as addicted as junkies to high oil prices; they have become accustomed to the significant cash flow $100 oil generates and don’t want their allowance cut. However, Saudi Arabia charged ahead anyway, with the apparent goal of running upstart US shale oil producers out of business (other theories speculate that Saudi Arabia did this to punish Iran and Russia (for supporting Iran) but these theories seem pretty kooky and tenuous, like, say, trying to punish Germany by promoting comedy.

But this time around something bizarre happened. The other OPEC countries sat there like sheep, uttering hardly a sound. And this is a big deal; some of the countries (like Venezuela) are pretty much broke and have no evident means to feed their bureaucrats, never mind balancing their budgets. So why did they voluntarily sit back and let the rich bully from the Middle East allow their cash flow to be cut in half?

The only logical explanation for this uncharacteristic amiableness is that Saudi Arabia promised something in return for the silence. Sit, shut up, watch the plan unfold, and you will be rewarded. There is no other way to view it, these countries are going bankrupt before our very eyes.

So what they were bought off with is the question. Well, it’s not that hard to figure out, the only thing that the Saudis could promise is higher oil prices. And how do we know that the Saudis can promise higher prices?

For years the Saudis held the oil markets in the palm of their hands, telling the world that they were the only country in the world capable of adding or subtracting meaningful amounts of oil. They could shut in millions of barrels per day and survive, few other countries could do that (or would even think of it). The Saudis also told everyone they had millions of barrels a day of spare capacity they could turn on whenever they wanted like a garden hose. So the whole world took oil price cues from their actions.
This time around they’re acting like all their previous antics never happened. They changed their story entirely, saying oil prices need to be set by the market. They cranked up drilling, with more oil rigs busy in Saudi Arabia today than ever have been before. They got their OPEC stooges to shut up and take it up the tail pipe without squawking, which in the past would have been inconceivable.

It seems that Saudi Arabia bought off their silence and the only way to do that was with the promise of much higher oil prices when the smoke clears. There is no other way that these countries could have afforded to sit silently while this happened. Saudi Arabia is going all-out to crush shale oil and oil sands development, and any other higher cost production in the world. Once that has been done, and they’re getting close, expect Saudi Arabia to rein in their production. Three years of $50 oil for 10 years of $250 oil, then we all go green…