The Flinchum File

Thoughtful Economic Analysis and Existential Opinions
Subscribe to the Flinchum File
View Archives

Opaque OPEC

Although OPEC is currently meeting in Vienna, little is expected, despite a flurry of activity behind the scenes.  Before the conference, the smaller producers were asking the “swing” producers like Saudi Arabia to reduce their own production levels to decrease the supply of available, which would drive up the price of oil and prop up the revenue of the smaller producers, at the expense of the larger producers.  Saudi Arabia has agreed to do this in the past but only rarely.

Also before the conference began, two non-members of OPEC showed up, i.e., Russia and Mexico.  Initial reports were that they were there to plead with OPEC members to reduce production.  Subsequent reports suggest Russia and Mexico were actually summoned to appear, so that OPEC could appeal to them to go along with any production cuts made by OPEC members — an obvious attempt to spread the pain.
Then, Saudi Arabia said they would not cut production, causing oil prices to drop even more rapidly, and the shares of oil companies are dropping as rapidly as shares of airlines are taking off.  One Russian oligarch predicts oil will now fall another $10, to below $60/bl.
Today, it is reported that erstwhile ally, Saudi Arabia, does not see this short-term problem of a revenue drop as significant as the long-term threat of American energy independence, resulting from our shale oil production.  The rule-of-thumb is that shale oil production in the U.S. costs about $65/bl to produce.  If prices fall below that, the U.S. will shut-in those oil wells and begin losing its energy independence.
Obviously, the long-term implications of this loss of independence are profound.  I think that becomes a matter of national security, and I pray that our do-nothing government can actually protect that independence.
Of more immediate importance, about 15% of high-yield bonds (AKA junk bonds) over the last two years have been related to shale oil production.  If those companies start going bankrupt, when oil prices fall below $65, that fixed-income market will be hurt badly.  Income investors will be hurt the most.
It is possible to have too much of a good thing.  A small drop in the prices at the pump is good for America.  A big drop is definitely not!