CEO's Blog

Good morning!

I live in Alberta, where oil is an obsession and a way of life. Unfortunately for Albertans, the news is not good these days.

In Oil’s Big Tumble, I commented on the breathtaking collapse of the price of oil, from its lofty height of $147/barrel to $66 (Oct. 22). Since then, the price of oil has plunged further, at one point dipping below $40 before rebounding to its current level of $49. This recent rebound, however, has everything to do with a momentary weakness in the U.S. dollar (oil is traded in U.S. dollars) and nothing to do with oil fundamentals.

As I pointed out in Oil’s Big Tumble, OPEC’s bark is worse than its bite when it comes to actually implementing production cuts. And looking at this graph, it’s not hard to see why. The Gulf Cooperation Council (GCC) states currently need oil prices to be at least $50/barrel (at current production levels) in order to pay for government spending programs.

This need of OPEC members to sustain oil revenues at a time of increasing government spending is creating a perverse variation on the classic prisoner’s dilemma. If one OPEC member state maintains (or increases) oil production while the other OPEC members cut production, then that OPEC member state benefits from increased oil revenues. If all OPEC member states cut production, then oil prices are increased marginally, benefiting all to a degree. But if all OPEC member states ignore the call for production cuts, then oil prices continue to fall and cartel members suffer from reduced oil revenues. Under this scenario, it’s easy to see why OPEC members want the cartel to agree to production cuts. It’s just that none of the OPEC members actually wants to implement the agreed upon cuts themselves.

So, I maintain my view that oil prices will continue to fall well into 2009, and could even test the lows of 1998, when oil traded at $9/barrel. While this trend will eventually reverse itself (U.S. dollar strength is unsustainable), the bottom in the oil market may not be reached before late 2009. In the meantime, expect substantial negative implications for Alberta’s oil-centric economy.

Yours truly,
John