Is OPEC about to go to financial war?

On Friday, Dec. 4, the OPEC oil ministers met and as I anticipated, they decided to leave production levels unchanged. The official target for production is 30 million barrels a day; however, OPEC is actually producing about 31.5 million barrels a day. Many of the oil ministers discussed the economic problems that their countries were having with the price of $40 a barrel. These nations wanted production cuts, hoping that prices would rise. Five are running out of money, what OilPrice.com calls the “Fragile Five”: Algeria, Iraq, Libya, Nigeria and Venezuela. As I pointed out in our article earlier this month, many of the OPEC members are running out of money and these financially strapped nations’ oil ministers at the OPEC meeting begged for production cuts in hopes that prices could rise in turn, helping their economies. Their requests fell on deaf ears.

{mosads}The ministers were concerned that current production level will be elevated when Iran, Libya and Iraq potentially bring an additional 4 million barrels a day to the market. All of this production will not come on at the same time, but the run rate should reach 35 million barrels a day by mid-2016. It’s hard to imagine that oil prices could rise with so much excess capacity coming into the market. One of the challenges with these three nations coming on board with more capacity is that the volume of oil inventory around the world is reaching capacity. The U.S. Department of Energy indicates that America has storage capability for approximately 520 million barrels of crude oil; currently 487 million barrels are in storage, so America doesn’t have a lot of room to store, especially if the economy falters and demand starts to fall.

According to the International Energy Agency (IEA) “Oil Demand Report,” there is an excess of 3 billion barrels in current inventory. If the three nations come back to the oil markets offering close to 4 million barrels a day, then short of a significant reversal in the global economy and increasing demand, inventories will grow by another 1 billion barrels from these nations alone, putting downward pressure on prices.

The economic outlook for world growth according to the International Monetary Fund has been reduced for 2016 to 3.5 percent. Citibank issued a report on Dec. 2 saying that it sees a 65 percent chance of a United States recession in 2016.

So with global economies in trouble, demand for oil will not recover and in turn, I believe prices may fall to perhaps $30 a barrel. The economic risks of a global recession at this time could blow up OPEC. The non-Middle Eastern oil producers like Algeria, Nigeria and Venezuela will see their economies destroyed by falling oil revenue. The desire to try and survive will, I believe, cause the possibility of a possible split within OPEC when the price drops below $35 a barrel. The discussions will accelerate if the price breaks $35.

In my headline, I use the word “war.” If the weaker nations try and pull out of OPEC, then look for the stronger nations, such as Saudi Arabia, to threaten to attack their market share and take the market share of the weaker nations as a way to punish them for trying to break away from OPEC. With so many OPEC members in dire financial straits, lower prices will bring significant pressure from citizens demanding services from governments that do not have money to make the payments. The people in these non-Middle Eastern countries will take to the streets and force governments out. As we saw when the Venezuela government changed hands, the professionals who were running the oil refineries and pipelines left the country. Venezuela found itself with some of the largest reserves in the world, but nobody with the skills to get it out of the ground and process it. Now a nation with some of the greatest reserves in the world is importing oil.

No discussion about the OPEC meeting would be complete without some comments on the price of gasoline in the United States and what’s going to happen to the energy industry in the America. The American Automobile Association’s “Daily Fuel Gauge Report” currently shows a national average of $2.02 for regular gasoline. The Detroit Free Press reported that at $1.53 a gallon, Detroit has the lowest price in America. The market did not sell off appreciably after the OPEC meeting report was announced, closing the day at $40.14. So if crude world to drop another $5, we can see the pump price approach a national average of $1.75 per gallon, with prices in some areas of the country lower and in some areas higher.

According to Stephen Stanley, chief economist of Amherst Pierpont, “Every penny that gas prices decline puts about a billion dollars into Americans’ pockets.” One year ago, the average price of a gallon was $2.75 vs. $2.05 today. If gas prices hold at this level, then the savings will be 70 times a billion, or $70 billion. If, as Citibank suggests, we have a 65 percent chance of a recession in 2016, then low pump prices could soften the blow.

One last thought: Two giants collide on the price of oil. Goldman says it thinks crude will hit $25 a barrel and T. Boon Pickens, the well-known oil man, thinks oil could be $70 by mid-2016, if not sooner. In over 41 years of investing, I have never seen such a spread in one asset class. Any further significant decline in the price of crude oil will have a devastating impact on the drillers, more than any other segment of the energy industry. The pipeline companies and the refiners probably have the best chance of holding value because they don’t take the risk of finding the oil. In reality, it is only a matter of time until energy will reverse its direction and go higher; the question is, can it go up enough to be worth the risk? Enjoy the savings that these low gas prices are producing and set some of the savings aside, just in case Citibank is right on the recession.

Perkins is a current events commentator and contributor to The Hill. He is the author of “The Brotherhood of the Red Nile” trilogy, a fictional account of radical Islamic nuclear terrorism against the United States.