Price dislocation makes planning difficult. Central bankers, therefore, telegraph their policy intentions (as long as you are familiar with their arcane jargon), so that affected economic participants can plan their lives in an organised fashion.
In the energy sector, price shocks lead to the development of alternatives e.g. electric vehicles, where Tesla is the poster child. OPEC, in the role of the central banker of oil, therefore also often telegraphs its intentions in order not to startle the market. Borrowing a phrase from Mario Draghi of the ECB, the Saudi Energy Minister Khalid al-Falih said this week that the oil producers would “do whatever it takes” to rebalance supply & demand in the oil market. As per the chart below, the production cuts over the last six months have largely achieved this.
But the oil producers have two large problems. Firstly, huge strategic inventories have built up during the recent period of low oil prices, to the extent that Donald Trump is talking about selling off part of the USA’s Strategic Petroleum Reserve (SPR). For context, OPEC produces a little over 30 million barrels per day. The USA SPR holds nearly 700million barrels.
Secondly, as per the following chart from Goldman Sachs, the cost curve of oil production has flattened significantly since 2014, with the result that more oil can be produced at any given price than was possible three years ago. Worryingly, for producers, this will very likely lead to a vicious deflationary feedback loop of more oil coming to the market at lower prices.
Prior to OPEC’s announcement on 24th May, forward guidance from OPEC et al. pointed to an extension of earlier production cuts for an additional nine months, and also increase the size of the production cuts.
But, alas, while the status quo has been extended for another nine months, the anticipated increased cuts failed to materialise, and the oil price fell by nearly 7% on Thursday afternoon.
So why would one of the most liquid(!) globally traded markets in the world fall aggressively in the face of what was ostensibly bullish news?
In most spheres of life, unfulfilled expectations lead to disappointment and frustration. Be it personal promises, expected service levels, hoped-for investment outcomes or, in this case, an insufficiently bullish announcement, the perception of dashed hopes invariably triggers overreaction. From central bankers to investment advisors, from parents to life partners, we all have to be incredibly careful about managing expectations, lest we trigger disappointment and/or frustration in our audience.
As a postscript, in much the same way as the Springbok rugby team was once a feared opponent but is now a shambles, it is clear that OPEC is now similarly toothless. Its bark is worse than it bite. It, therefore, seems the best that OPEC can now hope for is a relatively stable oil price at a level which is low enough to slow the inevitable arrival of electric vehicles.
Keeping Promises
