Fundamentals Of Crude Oil Pricing: Part II

If you have not read the first part of this article, it can be found here.

OPEC

The Organization of Petroleum Exporting Countries (commonly referred to as OPEC) is the world’s largest cartel. It consists of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. OPEC has control of roughly two-thirds of the world’s oil reserves and 35% of the world’s crude production (these numbers do not include tar sands and other unconventional forms of hydrocarbons). OPEC collectively places production quotas on its nations which in turn affect world wide supply. Often times countries within OPEC ignore quotas to promote their own economic interests but the net change from the total quota generally has been minimal.

Generally OPEC aims to keep oil prices increasing steadily at a rate slightly greater than inflation but there has been evidence and accusations of manipulating the market for other purposes, particularly in terms of the United States Presidential elections. Many industry experts believe that the Saudis (OPEC’s largest member) purposely hold reserves until around the time of the election, and either add or take reserves from the market to help push for the election of the candidate that is most likely to continue America’s reliance on foreign oil.

Obviously because transparency within OPEC is microscopic at best, this is impossible to prove but there has been a history of oil price spikes and drops around the half year before the election.

Russia

Depending on which day you look at the statistics, Russia is either the largest or the second largest producer of crude oil in the world. As you can imagine this allows Russia to have a great amount of pull in the world oil markets. While I do not believe Russia is currently trying to take crude oil off of the market to cause a price spike, I do believe they are supplying less oil to the rest of the market because they are consuming more to further their economic development. Their export numbers were down last quarter and I wouldn’t be surprised to see them hold steady or drop again when the next quarter’s numbers are reported.

Russia is currently listed as having the eighth largest crude oil reserve in the world, but I highly suspect that this number is inaccurate. Because of the political and economic instability that has taken place in the region over the last 50 years, proper surveying has not been completed and it is highly likely that within the next five to ten years there will be substantial oil finds in Russia. This is especially likely in the northern portions and offshore where very little work has been completed.

Another interesting factor when thinking about the future of Russia’s involvement with the world crude oil markets will be how it uses its political power. There have been rumors that Russia is interested in joining OPEC. This would instantly transform OPEC from a semi-legitimate cartel into the premiere market maker. While I still think this is unlikely, this type of move would be a way for Russia to take a backwards strike at the United States. Even if Russia joins OPEC it doesn’t necessarily mean that their power will increase because many of the countries within OPEC act as rogue members and do not listen to the production quotas set by the council. When a country can further it’s own economic interest, OPEC and its feelings take a back seat.

Russia has also been slowly encroaching into other oil rich areas that tend to be part of the former U.S.S.R. Georgia has sizable crude oil reserves as well as a key pipeline that supplies Europe with a lot of energy. If Russia were to take over Georgia, either literally or through political pressure, they would have an even larger energy stranglehold on Western and Central Europe, especially in terms of natural gas supply. Do not be surprised if you see either LUKOIL, Gazprom, or Gazprom Neft expanding their territory further outside Russia’s borders with the help of Vladimir Putin. Putin is an extremely smart and thoughtful leader who understands the need for natural resources going into the future and he has determined that those who control natural resources will control the world in the future. He is also an astute student of “cold-war” type politics and has proven this through his neglect of anything the West tries to offer.

Disclosure: COP owns a stake in LUKOIL and the mutual fund the author manages as well as the author’s family is long COP. The author’s family is also long PBR

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