OPEC cuts, Markets confused, Prices fall

The oil market has become a comedy of sorts. Every minuscule price movement is explained by some temporally correlating event with very little regard to causality.

Hence we get what we got yesterday with Opec's Algeria meeting and announcement of record production cuts. Alphaville blog from FT has the run down.

In short, OPEC announced record cuts. Conveying the message didn't go down too well. Markets were confused: what was the total magnitude of cuts? When will they start to really come into effect? Home much will the excess oil storage now accumulated last? Will the production quotas be honored by the members? What about Iraq's 'special circumstances' that enables it not to adhere to any quotas? Can they pick up the slack?

Thus, the price of oil kept falling and is yet again below $40/barrel, when producers know they need roughly $60-$65 pb to keep on investing.

Either markets are really confused and there will be a huge spike when we get out of the financial mess (not any time soon, mind you), OR we will have an interesting next year, when the cuts and capacity unwinding come into effect and slowly start squeezing the market. There is one more alternative: this will the biggest unwinding in the history of the world ever - everywhere. Markets will not recover in 2009, some not even 2010. Oil consumption and prices will stay low for a decade - as will economic growth. This is not a pretty scenario, but one that each one of us must entertain for now. It does have its upsides as well (emission reduction to mention one).

Currently, IEA/EIA inventories are still growing. And why shouldn't they: it'd be foolish not to fill inventories at these prices. Anybody who's looked at the production data and wants to plan ahead more than a few months, knows this much.

However, once the inventories and reserves are filled and IF demand picks up again, which it usually does at these price levels, get ready for some wild price action again.

When? Nobody knows.