This article was published by The McAlvany Intelligence Advisor on Friday, October 23, 2015:  

A month after OPEC decided in November, 2014 to keep pumping oil, columnist Nathan Vardi, writing in Forbes, said that “Saudi Arabia is making a massive $750 billion bet in 2015 that the kingdom can endure lower oil prices longer than other oil producing countries … including [the US].”

It now turns out that the bet was much larger, and it’s going against OPEC. According to Bloomberg, Saudi Arabia is being forced to delay paying its government contractors as those lower prices, which declined faster and more sharply and are staying down longer than expected, are pushing the country further into deficit. This is on top of the $4 billion that the country is borrowing every month to stay solvent. Despite its massive treasure chest of foreign securities, the Saudis no doubt are having second thoughts about just how much longer they can play this game of chicken.

The IMF gives the Saudis, and OPEC, little hope. If prices don’t rebound in the next five years, it estimates that those deficits will top $1 trillion!

Saudi Arabia has lots of company. Nearly every one of the major producers, including members of the OPEC cartel, is suffering serious negative cash flow problems. For example, Kuwait needs oil priced at $54 a barrel to balance its 2015 budget, while Nigeria needs $122 a barrel. Iran and Algeria need oil to be at $131 a barrel, while Venezuela needs oil at $160 a barrel to balance its 2015 budget.

For Saudi Arabia, its breakeven point is $106 a barrel, according to the Belfer Center at Harvard University.

What are the chances that the price of will rebound soon enough, and far enough, to rescue the cartel? Between slim and none if current reports across the globe are to be believed. There’s the Cass Freight Index, which measures the levels of global shipment activity from hundreds of its clients from a broad spectrum of industries. It showed a drop of 1.5% in September compared to last year, which was the worst September since 2010.

The Institute for Supply Management (ISM)’s September PMI (Purchasing Managers’ Index) fell by 6.2 percent, the third month in a row for that index, reflecting a 12 percent decline in new orders.

HSBC, the British banking giant, just reported that global has fallen 3.4 percent so far this year, while global trade has cratered by 8.4 percent. Exports from China in September were down 3.7 percent compared to a year ago, while imports into China dropped 13.8 percent in August, followed by another 20.4 percent decline in September.

Recent efforts to save itself have McDonald’s shares soaring, but the celebration on Wall Street may be premature. Back in May, the company’s new CEO, Steve Easterbrook, told his franchisees at a summit that “Our recent performance has been poor. The numbers don’t lie. I will not shy away from the urgent need to reset this business.”

Surveys of those franchisees following the summit showed gloom about the company’s future not seen in 11 years, with some of them doubting Easterbrooks’ ability to turn the company around.

Caterpillar, the world’s leading manufacturer of construction and mining equipment, diesel engines, gas turbines and diesel-electric locomotives, saw its profits drop from $1 billion in the third quarter a year ago to just $368 million in September. That’s a 70 percent decline, resulting in the company cutting its guidance sharply and announcing the layoff of thousands of its workers.

The latest from the International Agency (IEA) gives little hope to OPEC that any increase in the price of crude will be seen soon. The agency is saying that the glut of oversupply, coupled with decreasing demand (especially but not only) from China, will keep prices low, perhaps much lower. And for much longer, at least through next year.

It’s a perfect storm that OPEC never envisioned. From its myopic viewpoint, supply should have shriveled, and demand improved, to the point where it would have begun to show a profit long before now. It had hoped that supply from the United States would have started to drop precipitously, that demand from China and elsewhere would have continued to support higher prices, and that its position as leader of the OPEC would be assured.

All those assumptions are being questioned and the bet is turning against the Saudis. That’s the trouble with playing chicken.


Sources:

Wall Street Journal: Global Demand Growth for Oil May Fall by a Third in 2016

Wall Street Journal: Oil Falls on Pessimism About Oversupply

Wall Street Journal: IEA Sees Oil Market Remaining Oversupplied Next Year

EIA.gov: SHORT-TERM ENERGY AND WINTER FUELS OUTLOOK

EIA.gov: Oil Market Report: World Oil Demand

EconomicCollapseBlog: Global Trade Is Collapsing As The Worldwide Economic Recession Deepens

Marketwatch.com: Caterpillar slashes outlook as profit falls 64%

Marketwatch.com: Oil recoups some losses, but gains seen as short lived

Marketwatch.com: Will fiscal pain of low oil prices force Saudi Arabia’s hand

Background on Caterpillar

BusinessInsider.com: McDonald’s CEO reveals his massive plan to save the business

Background on McDonalds

Background on HSBC

Saudi Arabia’s $750 Billion Bet Drives Brent Oil Below $54

OPEC Leaves Production Target Unchanged

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