OPEC Calls Emergency Meeting

Under normal circumstances, OPEC would like to wait until after the US presidential election before announcing any controversial cuts in production. Any glance at the headlines will reveal these are far from ordinary times. Amid the financial crisis that has wiped trillions of dollars off equity exchanges worldwide, oil futures have halved since their peak in July. With prices dipping below $70 per barrel this week, OPEC called an emergency meeting for next Friday.

In recent months, crude oil has been trading primarily on concerns of supply disruptions. Violence in the Niger delta and damaging hurricanes in the Gulf coast helped lead a dramatic rise in prices over the summer. Now futures trade on fears of economic collapse. The global slowdown has eroded demand and lead to increasing inventories at refineries. US government data this week showed unexpectedly large stockpiles of crude oil and gasoline. Crude inventories were up 5.6 million barrels (against 1.9 million forecast) and gasoline inventories were up 6.97 million barrels (more than twice the 3 million expected).

Fears of recession and poor economic forecasts have undermined commodity prices across the board. Platinum, palladium, and zinc were all down double-digit percentage points, and even the secure metals (gold and silver) faced considerable losses. Margin calls on trading positions have put significant selling pressure on all commodities, but oil futures seems particularly vulnerable. Hedge funds, who rode their investments on oil futures to record profits, are now having to unwind their positions to meet their banking covenants. 

Many analysts say that these "forced liquidations" are skewing the market. Nevertheless, if refiners are not buying oil, there is no natural price floor. Even as OPEC hints at a production cut of 1 million barrels per day, the measure is unlikely to generate a price spike. In 1997, the Asian financial crisis (a fairly localized event) lead to a 10% decrease in global oil demand and a 3/4 drop in futures to around $8 per barrel. By comparison, current economic conditions resemble a massive earthquake (with an epicenter in the US and Western Europe) sending aftershocks spanning the globe. OPEC has reason to be gravely worried. 

Some journalists have called falling oil prices the "silver lining" of the financial crisis. Economists argue that such a precipitous collapse could signal a more worrisome phenomenon: deflation. When oil futures recede on account of waning demand, the price often falls below the cost of production. As a result, producers and refiners may be forced to lay off workers and shut down their facilities. Such economic contraction will have significant effects on political stability in OPEC nations, which are hugely dependent on the hydrocarbon sector. 

Qatari Oil Minister Abdullah al-Attiyah, the current head of OPEC, said the cartel will cut at least one million barrels "or more. Prices have fallen a lot, and we need to take measures." The same officials that were recently swimming in petro-dollars, buying up swaths of real estate in New York, are now scratching their heads. For anyone who thought oil futures would serve as a hedge against the equities collapse, the last few weeks have offered unpleasant evidence to the contrary.

Next week's meeting will be most interesting on a political level. It is easy to play along when oil is at $147 per barrel, but how will the member states behave in tough times? Saudi Arabia is the key player, but it will have to respect the domestic pressures in countries like Iran and Venezuela. If nothing else, perhaps this meeting will provide its own October surprise.