Crude Oil, OPEC, and Super Contango

On May 28th, OPEC will be meeting for the 153rd time in Vienna, Austria. During this meeting, much of the world will look to OPEC for additional guidance on Oil supply and demand; but should they? What will OPEC do? What can OPEC do? OPEC is between a rock and a hard place as market contango has pushed the price of crude to be almost perfectly correlated to the US equities markets.

Members of OPEC can neither afford to cut supply, or leave production levels the same. For if the cartel was to be successful in forcing oil prices up through production cuts, they run the risk of prolonging the economic crisis. However, if they don’t cut supply the world’s oil coffers will continue to spill over. They are trapped at the ultimate economic “rock in a hard place moment.” The only thing that is certain is that retail consumers without jobs, in conjunction with companies who are still aggressively scaling back, can ill afford a major increase in energy spending.

Over the next six months to a year, there will be no fundamental reason that demand should spike enough to erase the now staggering levels of global supply. Even if the so called “green shoots” fully blossomed it is inconceivable to think that demand will climb quickly to reduce supply. The world is currently swimming in oil and there is little OPEC can do about it in the short term.

As deflationary pressures drive all prices lower, reduce global demand, and move traders out of commodities and towards safety, the price of oil will continue to fall. I think prices will fall so hard in fact, that it would not be inconceivable to see oil return to 2004 prices of around $25/bbl within the next year to year and a half. In turn, I also expect to see the prices of both pump diesel and gasoline drop towards 2004 levels between $1.50 and $2.00 per gallon.

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