OPEC still has responsibility to control the market says Rowan Dartington’s Stephens

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Guy Stephens (pictured), director and board member at Rowan Dartington Signature highlights  OPEC’s role as central bank of oil.

The traditional year-end rally amid the season of goodwill is turning into a bit of a tumultuous experience. It feels like the hangover has come before the celebration and excessive consumption. There are suddenly lots of worrying headlines connected to the significant oil price fall which is now down almost 50% since June.

It stands to reason that when there is a significant move in a major market, it will upset some of the players who have been running their businesses based on a stable demand, supply and pricing environment.  When at least one of those variables moves significantly, then it is difficult to adjust quickly enough without some operators getting into difficulty.

When the revenue earned from selling a commodity halves in six months, there is going to be significant fall-out and many of the marginal oil businesses and peripheral players are going to feel the strain in the coming weeks and months as they fall into losses. There will also be collateral damage as bonds, which are backed by the operating assets of exploration and production businesses default, and investment in these businesses is curtailed, which will affect support service businesses involved with drilling and the supply of rigs.

This all took on a new dimension when OPEC refrained from cutting production after its meeting on 27th November in Vienna. It has also reiterated its stance over the weekend that it doesn’t believe that the fundamentals explain the fall in the price, quoting that demand and supply are not significantly out of kilter and that it is investigating the market movement. The real answer lies with the speculators who have sensed blood in a market where suddenly the Central Bank of Oil (OPEC) and chief supply regulator has resigned.

There are lots of political motivations involved, be it the pain inflicted on Russia and Iran or a desire to render US fracking uneconomic. However, it is not all bad news as over 75% of Western GDP spending comes from the consumer who is feeling the benefit in his wallet every time he fills up his car. There are implications for deflation but this is a drop in costs not demand and so, as with cost-push inflation, this does not necessarily lead to a squeeze in company profits, in fact the opposite is probably true.

There will be bad headlines ahead if the industry has to adjust to a $60 oil price, but the situation will stabilise and consumer spending will rise.  The inflation numbers will continue to fall over the next year at least but company profits, apart from the oil sector, should get a significant boost – think airlines, logistics, retailers, cruise companies and the like.

The risks to exposed areas of the debt markets and supporting banks are real but we would hope that the lessons of the credit crisis have led to balance sheets being strong enough to weather this storm. OPEC used to account for two-thirds of the global oil supply, hence its role as the price-maker. This has now fallen to one-third but there is a disconnect between what the market believes is the role of OPEC and its own perception.

Any market where the central price-setting mechanism suddenly disappears usually goes into flux, not unlike a currency peg being removed in foreign exchange. For now, the speculators are in charge and fortunes are being made and lost – we would hope that global pressure on OPEC to stabilise the market will soon prevail as they suddenly wake up to the degree of their influence, even if that is less than it was.

Ultimately, we could see the disbanding of OPEC but for the time being they have to realise that they still have a responsibility to control the market, regardless of whether they want it or not.

Mona Dohle
Mona Dohle speaks German and Dutch, she is DACH & Benelux Correspondent for InvestmentEurope. Prior to that, she worked as a journalist in Egypt and Palestine. She started her career as a journalist working for a local German newspaper. Mona graduated with an MSc in Development Studies from SOAS and has completed the CISI Certificate in International Wealth and Investment Management.

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