Wednesday, February 24, 2016

Saudi And Russia Make The Case For Efficient Markets

Saudi and Russian oil producers agreed to freeze oil production at current levels.  That decision will make things difficult for high cost producers who wanted a cut in oil production to avoid a further decline in the price of oil.  A Saudi official told an audience of energy producers in Houston that they should respect the market forces that are underway.  The market will determine which producers will survive.  The high cost producers of shale oil and Canadian tar sand oil will need to cut costs to compete with low cost Saudi and Russian producers.  If they are unable to become more efficient they market will force them out of business just as it is supposed to do.  Prices will continue to fall in response to an imbalance between supply and demand drive them out of business.

That was a tough message coming from a Saudi official who led the oil cartel which has carefully managed oil production to manage the price of oil for many years.  It wants to drive the high cost producers out of business so that the cartel can get back in the business of managing the price of oil. Many of the high cost producers have been borrowing heavily in order to survive the drop in prices.  Much of their debt has become junk debt with yields as high as 20%.  The banks that hold this debt are in as much trouble as the producers.

The Saudi minister must still be chuckling after delivering his message about efficient markets to an audience that firmly believes in the market system that is killing them.

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