The settled science of oil

Instapundit » Blog Archive » THANKS, FRACKERS! Don’t Look Now, but the Global Oil Surplus Just Tripled. Way back in June of…
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Well, I settled in on the fact that the world had a serious oversupply a long time ago, the oil bulls still have not or prices would not be hovering near $40 bbl. There is no reason except the inability to accept reality for oil prices to be above $30-35 bbl.

"This ought to give the delegates from various petrostates assembling in Algiers next week extra motivation to come to an agreement to freeze their collective agreement. The Saudis, for their part, seem more willing to play ball this time around, and have reportedly agreed to cut production by 1 million barrels per day if Iran joins in and other countries roll back their output to levels they hit earlier this year."

Whut? Statements like this simple come from a total lack of understanding of the geopolitical status of these oil tyrannies. Which one could withstand a cut in oil revenues in the face of a long term, probably permanent supply glut? 

Not one. Russia is falling apart economically, it is out of money, its currency is in collapse, its reserves in shambles. It cannot withstand a revenue cut of 30% for two years.

Neither Saudi, or Iran are willing to suffer such a cut, and Saudi cannot withstand a 2 year long 30% revenue decline. Such a cut would result in Saudi burning through all or most of its reserves, and there is no evidence that a cut like this would even result in an oil supply rebalancing. There is simply too much new supply, and any cut would cause these new suppliers to quickly enter the market and soak up the higher prices.

In addition, the House of Saud, and Iran are locked in an existential proxy war between the Shia, and Sunni/Wahhabi/Salafi factions of Islam. Since Iran has a real economy, plus oil, but the House of Saud has only an oil economy, Saud cannot afford to not pump oil. If it were to do so, and its reserves were lowered it could be forced to fire sale a large portion of Aramco to fund a resurgent Iranian proxy war. This would be devastating, and permanently alter the balance of power in the Middle East. Saud is walking a very fine line, it cannot afford to actually cut production.

The other OPEC producers are in are in equally bad shape, look to Venezuela to understand the problems these nations are attempting to avoid.

If an agreement is reached, I will predict that it will not be followed, and each party to the agreement will act as if it is complying while not complying. The oil price might rebound, but it will not be able to maintain the new level because all of the actual evidence will be that the oversupply continues. These countries cannot afford to stop selling oil, so they will. The Oil Bulls fantasy that these nations will actually cut production is just that, fantasy.