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Kilduff: Why OPEC Cut May Be Just The Beginning

Wednesday, 10 Sep 2008 | 3:00 PM ET

OPEC ministers went ahead with a decision to reduce oil output, as they set out to defend the $100 price level for crude oil.

Clearly, the cartel has been startled by the precipitous drop in prices from the all-time high set back in July, of nearly $150 per barrel. The majority of members prevailed upon a reluctant Saudi Arabia to go along with the reduction. The Saudis were likely feeling the heat from their peers, who felt that they were almost baited into the last production increase, due to the price rise.

It is not surprising to see Saudi Arabia go along with their counterparts. The Saudis have learned the hard lesson over the years of an undisciplined production regime and its consequence. OPEC was seemingly powerless to halt the price juggernaut, as most members produced at full capacity. The extremely high prices sowed the seeds of their demise, in terms of consumer demand that finally buckled under the strain.

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CNBC.com Feature Article:

OPEC Output Cut Won't Stop Oil Prices From Falling

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No one can suggest that $102 per barrel is a bargain -- which was the Saudi position going into the meeting. However, most members expressed their desire to maintain price levels in the $100 neighborhood. By acting now, the attempt is being made to halt the slide.

Demand continues to contract, as the most recent data from the International Energy Agency shows, as well as weekly U.S. data from the Energy Department. If the trend continues, OPEC will have to undertake a good deal more cutting in the weeks and months ahead.

Supply and demand dynamics are only a part of the story. The dollar’s rally has been equally swift, but it represents more of a race to the bottom, among the various world economies, than any kind of U.S. economic ascendancy. Our economy is looking less bad, right now, than Europe’s or Japan’s economy.

If prices are to continue precipitously lower, another shoe will need to drop. That will come in the form of reduced economic activity in China. If their industrial output and consequent energy demand slackens, crude oil could easily trade down to $85 per barrel.

At this point, though, I believe the Chinese economy will maintain a level of growth sufficient to stave off energy prices falling another 20 percent. While forecasts of $150 per barrel by year-end are too rich for my blood, I don’t see much lower prices in the cards, either.

OPEC’s ability to manipulate prices has been called into question in recent times. As I mentioned, above, they were unable to stem the price rise with production increases; and the market has reacted almost defiantly to production cutbacks in previous years.

During the run up, I always feared OPEC could have made matters worse, but they did not. I doubt their ability to muster the discipline needed to ameliorate a price decline driven by contracting demand, as well. I liken the group to dieters around a dessert table, during times of needed production rollbacks.

The grey cloud in this silver lining of lower energy prices is the deteriorating global economic outlook. At least, when prices were rising, there was a backdrop of frenetic economic activity, especially in Asia. I am not sure how good we are all going to feel overall, if energy prices fall dramatically because there is not very much going on out there in the world.

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Energy ETFs:

- United States Oil Fund

- United States Gasoline Fund

- iPath S&P GSCI Crude Oil Total Return Index

Refiners:

- Valero Energy

- Marathon Oil

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John Kilduff
John Kilduff

John P. Kilduff Senior Vice President Of Energy at MF Global Ltd. He's also a CNBC contributor.

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