Greasy Swoon

Brent’s precipitous slide from $126 to $90 a barrel could prove to be a deceptive correction. Fear may be dominating for now, but if the worst can be averted in Europe, oil traders may find they’ve been taking too dim a view of the global economy’s prospects and too sanguine a view of oil supplies and geopolitics.

Today’s oil price is already below the budgetary break-even point for more profligate OPEC producers. Saudi Arabia, whose bumper production has kept the cartel’s output ahead of its official target despite a clear slowdown in global growth, doesn’t tip into the red until $80 a barrel. But, it has said that a price closer to $100 is ideal.

Oil bears take comfort that there are few signs of the Saudis being prepared to cut production to nudge prices back up to this stated target. That hesitation may be self-interested: even producers get that lower crude prices act as needed stimulus when the global economy is sputtering.

But there are also strategic geopolitical reasons to keep pumping. In thrall to euro zone fears, oil markets have been blasé about new Iran sanctions that take effect on July 1. Uncertainties still surround the impact of these sanctions, including whether shippers will find ways around restrictions on insuring Iranian crude cargoes. If the sanctions prove more disruptive to supply than expected, or if stalled nuclear talks lead to a flare-up in geopolitical tensions, the extra Saudi production will have proved a wisely accommodating policy.

And, if the sanctions go smoothly, the Saudis still have production cuts in their toolkit. Global demand could also surprise, particularly if China starts to loosen policy aggressively to combat a slowdown.

With Iran still an unknown and China still at least partly in control of its economic destiny, it isn’t inconceivable that crude could move higher by year-end, as long as Europe muddles through. The fact that the world’s swing producer says it would like to see oil $10 higher may be as good a guide to long-term prices as any.