How Low Can They Go?

As I told you just a little while ago in my blog, OPEC said that as of January 1 it will cut oil production by an additional 2.2 million barrels a day. The cartel caught most analysts off guard, as Wall Street was expecting a two million bpd production cut.

This action now brings the total barrels of oil removed from daily production to 4.2 million since September.

OPEC’s President had this to say: "I hope we surprised you—if not, we have to do something about it.” Why? You have to remember, a lot of these countries are dependent on oil exports to generate revenue for their economies. Most OPEC members need crude prices of at least $70 a barrel to even balance their budgets! It’s for this reason that I’ve been telling you to expect further cuts from the oil cartel before the year is out.

Now, the $64,000 question on everybody’s mine seems to be, will this halt the slide in crude oil prices? Well, after rising in early morning trading, oil prices fell more than $3 toward the $40 level following OPEC’s announcement.

Investors were reacting more to an Energy Information Agency report released earlier today that said crude oil inventories increased 500,000 barrels from the previous week. Analysts were expecting to see a decline of 900,000 barrels of crude, so the data showed that inventories in the United States—the world’s biggest consumer—continue to swell.

There are a couple of reasons for this, but the primary one is that the recession is still battering global demand for fuel, which is why inventories keep growing. Oil prices are already more than $100 off their summer high of $147 a barrel, further indicating that the oil market is under pressure from the global financial crisis. Since this is the case, OPEC’s influence is diminished.

Believe it or not, there are other forces in play that could put a floor under oil prices. For one, Azerbaijan and Russia—two nations outside the OPEC block—are making their own production cuts.

And I’m confident that global demand won’t remain at these low levels forever. Remember, oil is a seasonal commodity. Prices will perk up again, especially now that a colder than usual winter is underway. Already, in some parts of the country we’ve seen record snowfall and ice. Consumers will be turning up their thermostats very soon if they haven’t already.

It’s still too early to tell if OPEC’s production cuts will make any real difference over the long term, but I’m confident that once the economy starts to bounce back, crude oil prices will resume their upward trek.

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