Note: they have been perpetually bearish on crude these past months, with good sense. Now is their argument fallacious? I Wonder Why OPEC Output Fell in March? April 07, 2008 8:10:AM ET By Tom Waterman New York, NY - Bloomberg reporters searching for answers this morning concluded that crude oil was up in overnight trading due to two factors. The first factor was a weakening U.S. dollar due to perception that the Federal Reserve would lower rates further after the poor economic news last week, especially the employment report. The second reason was that according to its surveys, OPEC output fell in March, and to emphasize how dramatic that sounds, it was the first drop in OPEC output since August, 2007. Here's why OPEC output fell in March, and will fall again in April. Several producers are running out of storage space and have resorted in some cases to filling tankers that never leave their harbors. They only have so much room for the growing glut of crude oil in the world. This is what international physical market traders tell us. It's also what tanker brokers tell us. The cycle of misinformation grows each day as some of the speculators reason that OPEC is cutting production to make certain prices stay high. So speculators buy and prices stay high as the total disconnect from reality continues. That's how this self-fulfilling prophesy of $100+ oil can be sustained. There is one factor that the U.S. administration has severely underestimated. We have been saying for months (actually since October, 2007) that the mortgage crisis may have been the trigger that accelerated the downward spiral of the U.S. economy, but it's oil prices that will make certain the downward spiral continues. A look back in history can explain how oil prices can impact the economy. Ronald Reagan was elected in 1980 and inherited an economic mess from the Carter administration. It was his good fortune when Saudi Arabia, fed up with its role as "swing producer," which had resulted in a loss of market share, implemented the strategy known as "netback pricing. This resulted in a huge drop in oil prices, to under $10 per barrel, that devastated the U.S. oil industry but recaptured much of its lost marketshare. The message the Saudis sent to the rest of the world was clear. They would not be denied their markets. Houston was a ghost town in those days but the rest of the economy soared. Cheap oil fueled the comeback and now it's working in the reverse. Several economists have said the U.S. economy can handle $100 per barrel oil. Perhaps it can, but at what cost? Back in November we wrote about how many industries simply cannot handle these prices because they cannot raise prices high enough to compete and make a profit. We noted that industries such as the airlines and the trucking business would be the first casualties of these prices, and without price relief, entire segments of industry will fail. There have already been a few bankruptcies among the airlines, and more to come as jet fuel prices have soared. Just six months ago, spot jet fuel in NY harbor was valued at $2.2957 per gallon. On Friday, April 4, jet fuel was $3.4421 per gallon in the harbor, an increase of 50% in six months. Many airlines are hedged but as those hedges expire, it will expose all airlines to the new pricing era. To understand what the trucking industry is experiencing, the independent trucker protests around the country certainly made clear their dilemma. It costs twice what it did six months ago to refuel. As this pressure expands to the huge trucking companies, that are also hedged, just like the airlines, they will be having the same problems as their independent brethren. It won't stop there either. Delivery services are feeling the heat. Most are hedged as well, but again, those hedges will expire and more expensive hedges will be put in place. What will follow will be hefty increases in delivery services that affect a large swath of the economy. There is a long list of segments of the U.S. business world that will be tremendously impacted by prices at these levels. While the futures markets can provide risk management services, those services do not limit the exposure to the actual price of a commodity. In other words, everyone pays the piper at some point. Those increased costs eventually are passed on, which means inflation will only rise further in the months ahead. Since core inflation levels are shielded by the convenient non-inclusion of energy and food costs, it takes a little while for the affects to take hold. Any economist that says the U.S. can handle $100+ crude oil has not thought about how oil flows through the economy like veins in the human body. Eventually, every sector feels the pain, which means, every consumer feels the pain. Airline tickets are going up after the largest and best hedged airline can no longer operate without rising fares, and that's coming soon. The cost of traveling by car this summer is already well documented as retail prices are now the highest in history. Wages are stagnant, there is no discretionary fallback as the housing slump has eliminated most homes as the ATM of choice for consumers. Those homeowners that actually have equity available will be loath to touch it now, until a situation reaches emergency status. Then we have food costs. Despite the misinformation about corn-based ethanol as the source for escalating food prices worldwide, the real cause is high fuel prices, as in oil prices. High Ag commodity prices? Again, another self-fulfilling prophesy fostered by a cycle of misinformation and greed. Commodities seem to be the last bastion for those with money to invest and make money. As with all things cyclical, it cannot continue. At some point, as consumers cut back on everything from food to shoes, prices will come tumbling down. Demand is falling across the board, in virtually every business sector. Since it takes a while for the data to catch up to the reality, we may not realize how desperate things have gotten until it's too late to do anything about it. Yes OPEC output may have fallen in March. But one thing you can be absolutely certain about is that OPEC output would have risen if there was demand for that oil. None of these OPEC countries, or non-OPEC countries for that matter, would withhold a single barrel at these prices. So for Bloomberg to suggest a drop in OPEC March output is bullish suggests an absolute disregard for the fundamental realities the world faces today.