Oil Dynamics

The drop in oil prices since mid-year has been a significant development even though the broader ramifications for world growth, prices and policy are only being worked out.    Just as the inflation predicated in the US as a consequence of the Fed's serial QE has not materialized, so too the forecasts of a forever higher for oil prices as every one know we are running out of it, has turned into is opposite.  

With new multi-year lows in the December light crude futures contract yesterday, the downtrend continues, with the $80 a barrel level finally convincingly breaking.   The main impetus was Saudi Arabia.  In essence it raised its prices for Asia shipments, for the first time in five months.  At the same time, it cut the price of its products being shipped to the US.  

Saudi Arabia is experiencing a shrinking market share of the US market.  According to the Energy Information Administration, in August the US imported 27.7 mln barrels of oil from Saudi Arabia, the least in 4 1/2 years.  US crude output is at 30-year highs, but the Saudi's price cuts may tempt some Gulf refineries who can to distill the Saudi's heavier oil.    The ability to gain much market share in the US is limited, however, because most of the refining capacity is for the light sweet crude.  

The Saudis' decision undermines conspiracy theories that claimed the Saudi's were acting on behalf of the US to add to the pressure on Russia.  We played down such claims, and it seems clear that Saudis recognize the challenge of US shale producers.  At the same time, it is important to remember that there are several players at the table, and that the Saudis have rivals within OPEC as well.  The next important event will be in the coming days as other OPEC countries announce their December pricing.  Do they match Saudi Arabia's higher prices to Asia, (technically, a smaller discount from the Oman/Dubai benchmark, or take advantage to gain market share themselves? 

Lastly, and separately, we note that Russia and Ukraine struck a deal ensuring, as much as such agreements can ensure anything,  that gas flows are not interrupted through the winter (the agreement extends to March 15).  The value of the agreement is estimated around $4.5 bln. Assuming that some speculators and businesses were betting on or hedging the risk of disruption, the Russian/Ukraine agreement may spur some position adjusting.  That said, the Russian-sponsored election in east Ukraine (Donetsk and Luhansk) indicates that Putin continues to implement a strategy that will lead to the further dismemberment of Ukraine.    Still, it may be hard to muster the political will to implement another wave of sanctions against Russia for holding elections,