Iron Ore and Oil – The great commodity overload

In economics, a cartel is ‘an agreement between competing firms to control prices or exclude entry of a new competitor in a market’ (source Wikipedia). The question hanging off the lips of the oil industry today is ‘what is OPEC if not a cartel’?

In July 1979 Jimmy Carter addressed the American people with his ‘Crisis of Confidence’ speech. The crux of it was a desire to remove America’s dependence on imported oil, as the second energy crisis took hold and effectively held them ransom to the Middle Eastern exporters.

Carter set a number of goals, notably in point three, “To give us energy security, I am asking for the most massive peacetime commitment of funds and resources in our nation’s history to develop America’s own alternative sources of fuel – from coal, from oil shale, from plant products for gasohol, from unconventional gas, from the sun.”

36 years later this this speech is hitting home in unexpected ways. The US is in a situation where it produces more oil than it consumes, and as anyone who has ever worked at FIS will understand, that to win the oil battle you need the biggest market share.

However, Saudi Arabia as the senior partner in OPEC appears to be learning from the big four iron ore producers. Rather than tell the world that they were ready to stabilise oil production, they last week effectively annexed the cartel by reiterating their intention to commit to market share, in doing so lifting the ineffective quota system which they all ignored.

Saudi Arabia like Rio Tinto, BHP, Fortescue Metals and Vale is intent on driving out high cost competition by pushing prices lower. The main objective is to force the shelving of higher cost shale oil production that thanks to technology advances is bolstering the production figures in the US.

In doing, so those higher cost producers within OPEC – especially Venezuela – have been thrown to the wolves in the process. Politically, the US – and President Obama – is a loser again. With the market awash with Saudi crude the apparent question is how much further can the market fall.

The question really should be how far is Saudi Arabia willing to take this? Using the iron ore market as a benchmark, then they may find that higher cost producers can be very resilient at low prices for long periods of time, especially if further technology advances continue to drive shale oil costs lower.

A week ago the oil market shorts were getting nervous and rallying hard on the slightest of bullish news. What a difference a week makes: I’m selling the electric car and going to buy a Hummer. Prices may have been falling for over a year, but it’s only now that the gloves are really off and this is about to get ugly.