Don't fight the cartel

J.P. Szafranski, BridgeTower Media Newswires

“Don’t fight the Fed’” is perhaps the favorite aphorism on Wall Street, a community with a diversified and immense portfolio of aphorisms. The Federal Reserve, as the central bank of the United States, shoulders many responsibilities but its most important is to implement a monetary policy via control of the money supply (the amount of U.S. dollars floating throughout the global financial system). Financial market media and participants focus intently on changes to the target interest rate for Fed Funds, but how does the Federal Reserve implement its policy for practical purposes?

An interest rate is simply an expression of the cost of money. If endowed with a pure monopoly, how might one change the cost of something, be it widgets or U.S. dollars? To lower prices, more should be supplied and to raise prices, supply should be restrained. The Fed literally creates more dollars if it wants to lower the cost (interest rate) of money or conversely, it destroys dollars in order to raise rates.

So, by law, the Fed has an absolute monopoly on the market for supply of U.S. dollars. If an all-powerful entity decides that it’s time to raise prices on the good it essentially controls, only a fool would ignore this circumstance. We could and probably will write a dozen columns this year on the implications of Fed policy upon businesses, investors and every American citizen. But today let’s focus on the market for a different good with a different and very intriguing dominant market player.

Despite many premature predictions of its demise in recent years, the Organization of Petroleum Exporting Countries (OPEC), with newfound partner Russia, has used its significant market power to drain global crude oil inventories and drive oil prices higher.

While the Fed derives its power from U.S. law, OPEC’s dominion over the oil market stems from its members’ collective control over one-third of the oil produced globally each day. Throw non-member Russia into the mix and you get closer to one-half of every barrel produced by ROPEC. More importantly, because the forces of oil supply and demand attempt to balance on a knife’s edge, with periods of relatively small differences between production and consumption causing wild price swings, OPEC’s unrivaled control of excess global production capacity, estimated by Bloom­berg to be 3.315 million barrels per day, is what provides the cartel massive influence on the price of oil in the short run.

Skeptics are quick to point to the Achilles heal of any cartel; members will agree to collectively restrain production but then individually cheat by overproducing to profit further from higher prices. Indeed, OPEC’s long history is riddled with quota cheating from its members. However, the current round of production cuts (starting in January 2017) have consistently shown very strong adherence. The International Energy Agency (IEA) estimated that OPEC cut compliance hit a new high of 137 percent this January.

Why is it different this time? OPEC’s major members are either highly motivated to restrain production or are unable to meaningfully increase output. Team captain and heavyweight, Saudi Arabia, continues work toward a public share offering of its sovereign oil company Saudi Aramco. A healthy and balanced oil market would prime equity markets to help the Saudis maximize the value realized in a stock sale. Meanwhile, Venezuela is in the midst of a financial and humanitarian crisis and unable to invest as needed in its oil capacity. The country’s production has dropped 676 thousand barrels per day in two short years.

Russia has found it profitable to partner with their erstwhile geopolitical foe, Saudi Arabia. In fact, Reuters reported last week that the president of OPEC sees the two countries working toward a formalized long-term alliance with such a charter possibly being signed and official before 2019.

Things can and will change, so we’ll continue to keep track of the group’s words and actions, but for now investors and analysts would be well-served to not fight ROPEC’s will to maintain oil price stability.


J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.