Demand Suggests That Oil's Current Woes Could Be Short-Lived

When OPEC announced at the end of last year that they had come to an agreement to cut production by member countries and a few significant non-members I opined, here and elsewhere, that the effects of that on the price of crude would be less than many believed and probably also shorter in duration.

The logic behind that assertion was that the natural jump in prices would simply encourage U.S. shale producers to resume operations and the reductions would soon be offset. In addition, I suggested that, based on history, cracks would appear in the OPEC deal before too long.

Both of those things have, to some extent, transpired and as result we are seeing oil trading at three month lows after a big drop in the last couple of days. At this point, though, the selling looks close to overdone.

OPEC now faces a dilemma. They held off from any concerted action in support of prices for some time, even as crude dipped to around $30 a year or so ago. Now that they have decided to act, though, they have a lot riding on their action succeeding. It is not just the obvious short term economic benefits to oil producing countries that is at stake here; it is also the ability of the cartel to take effective action in the future.

If the current cuts are abandoned, it could easily signal the end of OPEC itself and they are unlikely to go down without a fight. There was already talk last week of decreasing production even further and if this correction continues then that at the very least that talk will become more frequent and more strongly worded.

I am by nature a contrarian, so my first inclination is to oppose a move like this, but my view here is based on more than that. The market has been focused on oil’s supply issues for so long that the other, equally important side of the pricing equation, demand, is now being overlooked.

Talk of “peak oil demand” has been with us for decades but has yet to materialize. That reality was just last week recognized by the International Energy Agency and companies such as BHP Billiton and Exxon Mobil are busy preparing for a surge in demand that would easily offset the current oversupply. Add to that the likelihood that OPEC will talk tough and give prices a short term boost and buying into this oil collapse looks like a much better strategy than joining in the selling.