Oil is starting the week back under US$60 a barrel as, yet again, the real market comes to terms with trader noise and gets on with the business of deflating the bubble – barring any genuine major supply shocks, of course.

On Thursday night oil enjoyed a partial recovery on knee-jerk reaction to reports that OPEC was looking to cut production by a million barrels a day. What the traders missed was some of the finer print pointing to the real problem for OPEC at present: there’s too much oil already in storage and it’s therefore getting harder to sell the stuff physically.

A footnote to the oil bubble was that it became a one-way bet to buy oil and hang on to it while prices were going up, running whatever storage capacity you might have at 100%. (Except for a local problem in the US after Hurricane Katrina, there has never actually been a shortage of oil – it’s always been available at a price.)

Now the game has changed. Holding oil in storage loses money for speculators and refiners when prices are falling, so there’s no rush to make sure every spare jerry can is full. Without a cut in production or a real supply shock, oil prices are indeed heading lower – with implications for everyone who’s jumped on the alternative fuels bandwagon.

And that’s just the easy stuff before touching the politics of OPEC and just where Saudi Arabia (the only genuine swing producer) sits with the US, especially when the Saudis have been investing in increasing their productive capacity.

Crude fell back under US$60 on Friday night when the market divined differences of opinion in OPEC, but Marketwatch.com reported an interesting comment from James Williams, an economist at WTRG Economics who said that a cut in OPEC production would increase spare capacity – and it’s the shortage of spare capacity that has been driving the market over the past two years. “An increase in spare capacity puts downward pressure on prices and could have a greater effect on price than a production cut,” said Williams.

Or there’s a Professor Anthony Sabino of St Johns University saying OPEC’s vague threat to curtail production is more a sign of desperation than a real threat.

“They’re running scared and are simply trying to prevent a freefall in prices down to $40 or $50 per barrel,” he said. 

Peter Fray

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