Opec: why Trump has Saudi Arabia over a barrel

David Sheppard and Ed Crooks in The FT

Reneé Earls has lived her whole life in west Texas, and watched oil booms come and go, but she has never seen anything like the buzz of activity in the industry today. “We are a hopping spot,” she says. “If you’re not working here, that’s because you’re not looking for a job, or you are unemployable . . . If you have a skill and want to work, you can name your price.” 

Ms Earls is chief executive of the chamber of commerce in Odessa, in the heart of the Permian basin, the shale formation stretching from west Texas into New Mexico that is the red-hot centre of the latest US oil boom. Production in the region rose by 1m barrels a day in the year to August, contributing to a record-breaking 2.1m b/d increase in US output that has made the country the world’s largest crude producer. 

The shale boom has not only transformed once rundown towns deep in the west Texas desert; it is increasingly reshaping the landscape of international politics. The emergence of the US as a born-again energy superpower — one of the key factors in the recent fall in oil prices — has led politicians in Washington to weigh how it might reshape some of its oldest alliances, raising uncomfortable questions for the oil producers of the Middle East .  

For Saudi Arabia, the US’s chief ally in the Arab world, the past two months have delivered a stark lesson in how its relationship with Washington has been redefined by the Texas oil revolution. 

On Thursday and Friday ministers from Opec, the oil cartel that controls roughly a third of global production, and its allies including Russia and Kazakhstan, will meet in Vienna to decide how to respond to the 30 per cent plunge in oil prices to around $60 a barrel over the past two months. With US output surging, and Russia and Saudi Arabia also producing at close to record levels, traders are convinced the market will be awash with oil next year. 

Previously such a fall would have prompted Opec and its allies to agree to cut production. But for Saudi Arabia, which remains the world’s top oil exporter and the cartel’s de facto leader, that decision has been complicated by the murder of Jamal Khashoggi. 

The gruesome killing of the Saudi Arabian journalist and Washington Post columnist, a critic of the royal family, has revealed fissures in its prized relationship with the US. 

US president Donald Trump has maintained his backing for Riyadh and Crown Prince Mohammed bin Salman, the country’s day-to-day ruler widely known as MBS, despite reports that the CIA has concluded that he ordered the operation against Khashoggi at the kingdom’s consulate in Istanbul. But his stance comes with conditions attached, one of which lies at the heart of the kingdom’s wellbeing: the oil price. 

In statements, tweets and private communications Mr Trump has made clear his support for lower oil prices and his opposition to Riyadh moving to cut production, heaping pressure on a royal court shaken by the international backlash against the Khashoggi killing. The pressure from the White House has come despite Saudi Arabia raising production this summer to help make sure the market remained well supplied as the US reimposed sanctions on Iran. Riyadh’s position as Tehran’s chief rival in the region reflects a core part of the Trump administration’s foreign policy. 

“The priority for Saudi Arabia is shoring up MBS’s position, and the key part of that is securing Trump’s backing,” says Derek Brower, a director of RS Energy Group. “Trump has clearly linked his support for MBS with several things . . . but it’s oil that seems to be at the top of his agenda.” 

For the Trump administration, the calculation is straightforward. Lower oil prices mean cheaper petrol, providing a boost for consumers. The president has hailed the recent fall in prices as a “tax cut”, giving him some good news after a stock market wobble triggered by his confrontation with China over trade. 

For Saudi Arabia, that creates a dilemma. Khalid al-Falih, its energy minister, has pushed ahead with plans to drum up support for cutting oil production by more than 1m b/d, but observers think he will be constrained by the need to appease Mr Trump. 

Bob McNally, a consultant who has advised US administrations on oil policy, says Riyadh’s position is precarious. “If they orchestrate a high-profile Opec-plus cut that boosts Brent crude back up towards $70 they risk Trump’s wrath,” he says. “[But] if Riyadh bends entirely to Trump’s will and keeps production at record levels, an inventory glut will return and the bottom will fall out of crude prices.” 

Ellen Wald, author of a history of Saudi Arabia’s oil industry, says the “ultimate success” for Riyadh from this week’s meeting would be “to quietly let people know that a cut is happening to raise the price, without drawing attention to the activity of Opec specifically.” 

Yet history suggests that kind of mixed message risks pleasing no one — angering Mr Trump while not doing much to raise prices. 

The stakes for Saudi Arabia are higher than just a single decision on output. Its alliance with the US has long been underpinned by oil supplies, with the resultant petrodollars recycled back into the American economy through the purchase of military hardware. 

After a fall in prices in 2014, Riyadh renewed its attempts to diversify and modernise both its economy and wider society, aiming to reduce its dependence on oil revenues. But for the programme to have a chance of success, Saudi Arabia needs a higher oil price in the short term to help fund the changes. 

The shale boom is eroding the foundations of one of the pillars of the alliance. US net oil imports, which peaked at about 13m b/d in 2005, have dropped to about 2.4m b/d this year. By the end of next year, they could be running at just 330,000 b/d, according to the US Energy Information Administration. 

Saudi Arabia’s crude supplies remain crucial to the world economy, and to US consumer fuel prices. But Amy Myers Jaffe, a senior fellow at the Council on Foreign Relations, says the US economy is much less vulnerable to a spike in prices than it was even a decade ago. 

The evidence of the crude price fall four years ago and subsequent recovery is that the impact of changes on the American economy is now roughly neutral. “The US is not in the position it was in 2007-08, when we were facing a rising oil price that put strain on the current account deficit and the dollar,” she says. “That’s a big change.” 

As politicians start to grasp the implications of that shift, it is strengthening the argument that the US no longer needs to shackle itself to Riyadh. 

“The atmosphere in Washington has certainly changed following the killing of Jamal Khashoggi,” says Helima Croft, a former CIA analyst who now runs RBC Capital Markets’ natural resources analysis. “Politicians see the surge in US oil production and are wondering aloud whether the alliance is as necessary as it once was.” 

Those questions are also starting to drive activity in Congress. Last week, the Senate voted 63-37 to advance a resolution demanding that the president end US armed forces’ activity “in or affecting Yemen”, where Saudi Arabia’s war against Iran-aligned Houthi rebels has exacerbated what aid groups describe as the world’s worst humanitarian crisis. 

Legislation that would allow the US to impose criminal penalties on members of Opec and their allies for acting as a cartel has also been making progress. For Saudi Arabia, which has extensive assets in the US including the largest refinery in North America, that legislation is a genuine threat. 

Tim Kaine, the Democratic senator from Virginia who was a co-sponsor of the bipartisan legislation on Yemen, suggested the Khashoggi death had been the last straw for some. “It was really important for the Senate to send a message to Saudi Arabia: ‘you do not have a free pass’,” Mr Kaine told National Public Radio last week. “The president’s signal of complete impunity is not in accord with American values.” 

In the autumn of 2014, the Saudi government tried to reassert its authority in the oil market against the nascent threat from shale. As a global glut of crude swelled up, Riyadh declined to cut production, in the belief it could drown the Texas producers in a sea of cheap oil. 

But shale proved far more resilient than Saudi Arabia — the only country with significant spare production capacity — had hoped. Two years on Opec members returned to restricting output, with the help of Russia and other non-member producers, to lay the foundations for a recovery in prices. 

As the oil price has fallen this autumn, the memories of that episode have been resurfacing. But Jason Bordoff of Columbia University’s Center on Global Energy Policy says there is at least one crucial difference. “We now know how resilient shale can be. We saw how companies could cut costs and become more efficient to keep producing. That complicates Opec’s decision-making,” he says. “This time around, Opec knows it can’t kill shale, but maybe just wound it.” 

Ms Earls says the people of Odessa have been watching as oil prices have plunged in the past two months. Fundamentally, though, they “still feel very confident”, she adds, because of the producers’ long-term commitment. The Permian Strategic Partnership, an industry-backed group that works with communities to help develop badly-needed infrastructure including roads, houses and schools, estimates a further 60,000 jobs will be createdby 2025, a huge increase for an area that had a population of about 330,000 last year. 

The rate at which new wells are brought into production in the Permian was already expected to slow, in part because of a shortage of pipeline capacity. If the fall in prices is sustained, it could mean the industry slows further across the US, raising questions too for the White House. 

The gains to consumers from lower fuel prices will be offset by the hit to investment. The oil-dependent economies of Texas and North Dakota would bear the brunt of the hit, but it would also extend to other industries such as steelmaking, which has benefited from the boom in pipeline construction. 

Bernadette Johnson, vice-president of market intelligence at Drillinginfo, a research group, says there are several oil producing regions, such as the Denver-Julesburg Basin of Colorado, Wyoming and Nebraska, where a fall in US crude from $60 to $50 would make a significant difference to the economics. 

“The companies think that it may just be a temporary thing, and that prices will rebound,” she says. “If the oil price stays where it is, we will see companies start to react.” 

Yet while there may be a temporary slowdown, there is a general confidence in the US industry that its growth can continue. US officials say they are not concerned about the impact of lower oil prices, arguing that the industry will be able to continue to grow thanks to technological improvements and efficiency gains. Others are more sceptical, noting that US production contracted in 2016 when prices were at their nadir. 

Will Giraud, executive vice-president of Concho Resources, one of the leading producers in the Permian Basin — where production is approaching 3.7m b/d — told investors last month: “I think there are several more years of very high growth, and it’s likely that the Permian gets into the 5m-6m or maybe even 7m b/d of production and then sustains that for a decent period.” 

In the face of rampant US shale output, Saudi Arabia looks like it may still decide that angering Mr Trump is a price worth paying for a production cut that props up the oil price, whatever the heightened risks from the Khashoggi affair. But regardless of what the Saudis decide, the flow of oil from places such as Odessa will keep quietly eroding one of the old certainties that underpinned their relationship with the US. As Mr Brower at RS Energy puts it: “The pressures that Saudi Arabia are under are already immense.”

How to get away with financial fraud

Dan Davies in The Guardian


Guys, you’ve got to hear this,” I said. I was sitting in front of my computer one day in July 2012, with one eye on a screen of share prices and the other on a live stream of the House of Commons Treasury select committee hearings. As the Barclays share price took a graceful swan dive, I pulled my headphones out of the socket and turned up the volume so everyone could hear. My colleagues left their terminals and came around to watch BBC Parliament with me.

It didn’t take long to realise what was happening. “Bob’s getting murdered,” someone said.

Bob Diamond, the swashbuckling chief executive of Barclays, had been called before the committee to explain exactly what his bank had been playing at in regards to the Libor rate-fixing scandal. The day before his appearance, he had made things very much worse by seeming to accuse the deputy governor of the Bank of England of ordering him to fiddle an important benchmark, then walking back the accusation as soon as it was challenged. He was trying to turn on his legendary charm in front of a committee of angry MPs, and it wasn’t working. On our trading floor, in Mayfair, calls were coming in from all over the City. Investors needed to know what was happening and whether the damage was reparable.

A couple of weeks later, the damage was done. The money was gone, Diamond was out of a job and the market, as it always does, had moved on. We were left asking ourselves: How did we get it so wrong?

At the time I was working for a French stockbroking firm, on the team responsible for the banking sector. I was the team’s regulation specialist. I had been aware of “the Libor affair”, and had written about it on several occasions during the previous months. My colleagues and I had assumed that it would be the typical kind of regulatory risk for the banks – a slap on the wrist, a few hundred million dollars of fines, no more than that.

The first puzzle was that, to start with, it looked like we were right. By the time it caught the attention of the mainstream media, the Libor scandal had reached what would usually be the end of the story – the announcement, on 27 June 2012, of a regulatory sanction. Barclays had admitted a set of facts, made undertakings not to do anything similar again, and agreed to pay finesof £59.5m to the UK’s Financial Services Authority, $200m to the US Commodity Futures Trading Commission and a further $160m to the US Department of Justice. That’s how these things are usually dealt with. If anything, it was considered quite a tough penalty.

But the Libor case marked the beginning of a new process for the regulators. As well as publishing their judgment, they gave a long summary of the evidence and reasoning that led to their decision. In the case of the Libor fines, the majority of that evidence took the form of transcripts of emails and Bloomberg chat. Bloomberg’s trading terminals – the $50,000-a-year news and financial-data servers that every trader uses – have an instant-messaging function in addition to supplying prices and transmitting news. Financial market professionals are vastly more addicted to this chat than teen girls are to Instagram, and many of them failed to realise that if you discussed illegal activity on this medium, you were making things easy for the authorities.

The transcripts left no room for doubt.

Trader C: “The big day [has] arrived … My NYK are screaming at me about an unchanged 3m libor. As always, any help wd be greatly appreciated. What do you think you’ll go for 3m?”

Submitter: “I am going 90 altho 91 is what I should be posting.”

Trader C: “[…] when I retire and write a book about this business your name will be written in golden letters […]”.

Submitter: “I would prefer this [to] not be in any book!”

Perhaps it’s unfair to judge the Libor conspirators on their chat records; few of the journalists who covered the story would like to see their own Twitter direct-message history paraded in front of an angry public. Trading, for all its bluster, is basically a service industry, and there is no service industry anywhere in the world whose employees don’t blow off steam by acting out or insulting the customers behind their backs. But traders tend to have more than the usual level of self-confidence, bordering on arrogance. And in a general climate in which the public was both unhappy with the banking industry and unimpressed with casual banter about ostentatious displays of wealth, the Libor transcripts appeared crass beyond belief. Every single popular stereotype about traders was confirmed. An abstruse and technical set of regulatory breaches suddenly became a morality play, a story of swaggering villains who fixed the market as if it was a horse race. The politicians could hardly have failed to get involved.

It is not a pleasant thing to see your industry subjected to criticism that is at once overheated, ill-informed and entirely justified. In 2012, the financial sector finally got the kind of enemies it deserved. The popular version of events might have been oversimplified and wrong in lots of technical detail, but in the broad sweep, it was right. The nuanced and technical version of events which the specialists obsessed over might have been right on the detail, but it missed one utterly crucial point: a massive crime of dishonesty had taken place. There was a word for what had happened, and that word was fraud. For a period of months, it seemed to me as if the more you knew about the Libor scandal, the less you understood it.

That’s how we got it so wrong. We were looking for incidental breaches of technical regulations, not systematic crime. And the thing is, that’s normal. The nature of fraud is that it works outside your field of vision, subverting the normal checks and balances so that the world changes while the picture stays the same. People in financial markets have been missing the wood for the trees for as long as there have been markets.

Some places in the world are what they call “low-trust societies”. The political institutions are fragile and corrupt, business practices are dodgy, debts are rarely repaid and people rightly fear being ripped off on any transaction. In the “high-trust societies”, conversely, businesses are honest, laws are fair and consistently enforced, and the majority of people can go about their day in the knowledge that the overall level of integrity in economic life is very high. With that in mind, and given what we know about the following two countries, why is it that the Canadian financial sector is so fraud-ridden that Joe Queenan, writing in Forbes magazine in 1989, nicknamed Vancouver the “Scam Capital of the World”, while shipowners in Greece will regularly do multimillion-dollar deals on a handshake?

We might call this the “Canadian paradox”. There are different kinds of dishonesty in the world. The most profitable kind is commercial fraud, and commercial fraud is parasitical on the overall health of the business sector on which it preys. It is much more difficult to be a fraudster in a society in which people only do business with relatives, or where commerce is based on family networks going back centuries. It is much easier to carry out a securities fraud in a market where dishonesty is the rare exception rather than the everyday rule.

 

Traders at Bloomberg terminals on the floor of the New York stock exchange, 2013. Photograph: Brendan McDermid / Reuters/REUTERS

The existence of the Canadian paradox suggests that there is a specifically economic dimension to a certain kind of crime of dishonesty. Trust – particularly between complete strangers, with no interactions beside relatively anonymous market transactions – is the basis of the modern industrial economy. And the story of the development of the modern economy is in large part the story of the invention and improvement of technologies and institutions for managing that trust.

And as industrial society develops, it becomes easier to be a victim. In The Wealth of Nations, Adam Smith described how prosperity derived from the division of labour – the 18 distinct operations that went into the manufacture of a pin, for example. While this was going on, the modern world also saw a growing division of trust. The more a society benefits from the division of labour in checking up on things, the further you can go into a con game before you realise that you’re in one. In the case of several dealers in the Libor market, by the time anyone realised something was crooked, they were several billions of dollars in over their heads.

In hindsight, the Libor system was always a shoddy piece of work. Some not-very-well-paid clerks from the British Bankers’ Association would call up a few dozen banks and ask: “If you were to borrow, say, a million dollars in [a given currency] for a 30-day deposit, what would you expect to pay?” A deposit, in this context, is a short-term loan from one bank to another. Due to customers’ inconvenient habit of borrowing from one bank and putting the money in an account at another, banks are constantly left with either surplus customer deposits, or a shortage of funds. The “London inter-bank offered-rate” (Libor) market is where they sort this out by borrowing from and lending to each other, at the “offered rate” of interest.

Once they had their answers, the clerks would throw away the highest and lowest outliers and calculate the average of the rest, which would be recorded as “30-day Libor” for that currency. The process would be repeated for three-month loans, six-month loans and any other periods of interest, and the rates would be published. You would then have a little table recording the state of the market on that day – you could decide which currency you wanted to borrow in, and how long you wanted the use of the money, and the Libor panel would give you a good sense of what high-quality banks were paying to do the same.

Compared with the amount of time and effort that goes into the systems for nearly everything else that banks do, not very much trouble was taken over this process. Other markets rose and fell, stock exchanges mutated and were taken over by super-fast robots, but the Libor rate for the day was still determined by a process that could be termed “a quick ring-around”. Nobody noticed until it was too late that hundreds of trillions of dollars of the world economy rested on a number compiled by the few dozen people in the world with the greatest incentive to fiddle it.

It started to fall apart with the onset of the global financial crisis in 2007, and all the more so after the collapse of Lehman Brothers in 2008, when banks were so scared that they effectively stopped lending to each other. Although the market was completely frozen, the daily Libor ring-around still took place, and banks still gave, almost entirely speculatively, answers to the question “If you were to borrow a reasonable sum, what would you expect to pay?”

But the daily quotes were published, and that meant everyone could see what everyone else was saying about their funding costs. And one of the telltale signs that a bank in trouble is when its funding costs start to rise. If your Libor submission is taken as an indicator of whether you’re in trouble or not, you really don’t want to be the highest number on the daily list. Naturally, then, quite a few banks started using the Libor submission process as a form of false advertising, putting in a lowballed quote in order to make it look like they were still obtaining money easily when, in fact, they could hardly borrow at all. And so it came to pass that several banks created internal message trails saying, in effect, “Dear Lowly Employee, for the benefit of the bank and its shareholders, please start submitting a lower Libor quote, signed Senior Executive”. This turned out to be a silly thing to do.

All this was known at the time. There was an article in the Wall Street Journal about it. I used to prepare PowerPoint slides with charts on them that had gaps for the year 2008 because the data was “somewhat hypothetical”. Even earlier, in late 2007, the Bank of England held a “liaison group” meeting so that representatives from the banks could discuss the issue of Libor reporting. What nobody seemed to realise is that an ongoing fraud was being committed. There was a conspiracy to tell a lie (to the Libor phone panel, about a bank’s true cost of funding) in order to induce someone to enter into a bargain at a disadvantage to themselves. The general public caught on to all this a lot quicker than the experts did, which put the last nail in the coffin of the already weakened trust in the financial system. You could make a case that a lot of the populist politics of the subsequent decade can be traced back to the Libor affair.

Libor teaches us a valuable lesson about commercial fraud – that unlike other crimes, it has a problem of denial as well as one of detection. There are very few other criminal acts where the victim not only consents to the criminal act, but voluntarily transfers the money or valuable goods to the criminal. And the hierarchies, status distinctions and networks that make up a modern economy also create powerful psychological barriers against seeing fraud when it is happening. White-collar crime is partly defined by the kind of person who commits it: a person of high status in the community, the kind of person who is always given the benefit of the doubt.

In popular culture, the fraudster is the “confidence man”, somewhere between a stage magician and the trickster gods of mythology. In films such as The Sting and Dirty Rotten Scoundrels, they are master psychologists, exploiting the greed and myopia of their victims, and creating a world of illusion. People like this do exist (albeit rarely). But they are not typical of white-collar criminals.

The interesting questions are never about individual psychology. There are plenty of larger-than-life characters. But there are also plenty of people like Enron’s Jeff Skilling and Baring’s Nick Leeson: aggressively dull clerks and managers whose only interest derives from the disasters they caused. And even for the real craftsmen, the actual work is, of necessity, incredibly prosaic.

The way most white-collar crime works is by manipulating institutional psychology. That means creating something that looks as much as possible like a normal set of transactions. The drama comes later, when it all unwinds.

Fraudsters don’t play on moral weaknesses, greed or fear; they play on weaknesses in the system of checks and balances – the audit processes that are meant to supplement an overall environment of trust. One point that comes up again and again when looking at famous and large-scale frauds is that, in many cases, everything could have been brought to a halt at a very early stage if anyone had taken care to confirm all the facts. But nobody does confirm all the facts. There are just too bloody many of them. Even after the financial rubble has settled and the arrests been made, this is a huge problem.

 

Jeffrey Skilling and Sherron Watkins of Enron at a Senate commerce committee hearing in 2002. Photograph: Ron Edmonds/AP

It is a commonplace of law enforcement that commercial frauds are difficult to prosecute. In many countries, proposals have been made, and sometimes passed into law, to remove juries from complex fraud trials, or to move the task of dealing with them out of the criminal justice system and into regulatory or other non-judicial processes. Such moves are understandable. There is a need to be seen to get prosecutions and to maintain confidence in the whole system. However, taking the opinions of the general public out of the question seems to me to be a counsel of despair.

When analysed properly, there isn’t much that is truly difficult about the proverbial “complex fraud trial”. The underlying crime is often surprisingly crude: someone did something dishonest and enriched themselves at the expense of others. What makes white-collar trials so arduous for jurors is really their length, and the amount of detail that needs to be brought for a successful conviction. Such trials are not long and detailed because there is anything difficult to understand. They are long and difficult because so many liars are involved, and when a case has a lot of liars, it takes time and evidence to establish that they are lying.

This state of affairs is actually quite uncommon in the criminal justice system. Most trials only have a couple of liars in the witness box, and the question is a simple one of whether the accused did it or not. In a fraud trial, rather than denying responsibility for the actions involved, the defendant is often insisting that no crime was committed at all, that there is an innocent interpretation for everything.

In January this year, the construction giant Carillion collapsed. Although they had issued a profits warning last summer, they continued to land government contracts. It was assumed that, since they had been audited by KPMG, one of the big-four accounting firms, any serious problems would have been spotted.
At the time of writing, nobody has been prosecuted over the collapse of Carillion. Maybe nobody will and maybe nobody should. It’s possible, after all, for a big firm to go bust, even really suddenly, without it being a result of anything culpable. But the accounting looks weird – at the very least, they seem to have recognised revenue a long time before it actually arrived. It’s not surprising that the accounting standards bodies are asking some questions. So are the Treasury select committee: one MP told a partner at KPMG that “I would not hire you to do an audit of the contents of my fridge.”

In general, cases of major fraud should have been prevented by auditors, whose specific job it is to review every set of accounts as a neutral outside party, and certify that they are a true and fair view of the business. But they don’t always do this. Why not? The answer is simple: some auditors are willing to bend the rules, and some are too easily fooled. And whatever reforms are made to the accounting standards and to the rules governing the profession, the same problems have cropped up again and again.

First, there is the problem that the vast majority of auditors are both honest and competent. This is a good thing, of course, but the bad thing about it is that it means that most people have never met a crooked or incompetent auditor, and therefore have no real understanding that such people exist.

To find a really bad guy at a big-four accountancy firm, you have to be quite unlucky (or quite lucky if that was what you were looking for). But as a crooked manager of a company, churning around your auditors until you find a bad ’un is exactly what you do – and when you find one, you hang on to them. This means that the bad auditors are gravitationally drawn into auditing the bad companies, while the majority of the profession has an unrepresentative view of how likely that could be.

Second, there is the problem that even if an auditor is both honest and competent, he has to have a spine, or he might as well not be. Fraudsters can be both persistent and overbearing, and not all the people who went into accountancy firms out of university did so because they were commanding, alpha-type personalities.

Added to this, fraudsters are really keen on going over auditors’ heads and complaining to their bosses at the accounting firm, claiming that the auditor is being unhelpful and bureaucratic, not allowing the CEO to use his legitimate judgment in presenting the results of his own business.

Partly because auditors are often awful stick-in-the-muds and arse-coverers, and partly because auditing is a surprisingly competitive and unprofitable business that is typically used as a loss-leader to sell more remunerative consulting and IT work, you can’t assume that the auditor’s boss will support their employee, even though the employee is the one placing their signature (and the reputation of the whole practice) on the set of accounts. As with several other patterns of behaviour that tend to generate frauds, the dynamic by which a difficult audit partner gets overruled or removed happens so often, and reproduces itself so exactly, that it must reflect a fairly deep and ubiquitous incentive problem that will be very difficult to remove.

By way of a second line of defence, investors and brokerage firms often employ their own “analysts” to critically read sets of published accounts. The analyst is meant to be an industry expert, with enough financial training to read company accounts and to carry out valuations of companies and other assets. Although their primary job is to identify profitable opportunities in securities trading – shares or bonds that are either very undervalued or very overvalued – it would surely seem to be the case that part of this job would involve the identification of companies that are very overvalued because they are frauds.

Well, sometimes it works. A set of fraudulent accounts will often generate “tells”. In particular, fraudsters in a hurry, or with limited ability to browbeat the auditors, will not be able to fake the balance sheet to match the way they have faked the profits. Inflated sales might show up as having been carried out without need for inventories, and without any trace of the cash they should have generated. Analysts are also often good at spotting practices such as “channel stuffing”, when a company (usually one with a highly motivated and target-oriented sales force) sells a lot of product to wholesalers and intermediaries towards the end of the quarter, booking sales and moving inventory off its books. This makes growth look good in the short term, at the expense of future sales.

Often, an honest auditor who has buckled under pressure will include a cryptic-looking passage of legalese, buried in the notes to the accounts, explaining what accounting treatment has been used, and hoping that someone will read it and understand that the significance of this note is that all of the headline numbers are fake. Nearly all of the fraudulent accounting policies adopted by Enron could have been deduced from its public filings if you knew where to look.

More common is the situation that prevailed in the period immediately preceding the global financial crisis.Analysts occasionally noticed that some things didn’t add up, and said so, and one or two of them wrote reports that, if taken seriously, could have been seen as prescient warnings. The problem is that spotting frauds is difficult and, for the majority of investors, not worth expending the effort on. That means it is not worth it for most analysts, either. Frauds are rare. Frauds that can be spotted by careful analysis are even rarer. And frauds that are also large enough to offer serious rewards for betting against them come along roughly once every business cycle, in waves.

Analysts are also subject to very similar pressures to those that cause auditors to compromise their principles. Anyone accusing a company publicly of being a fraud is taking a big risk, and can expect significant retaliation. It is well to remember that frauds generally look like very successful companies, and there are sound accounting reasons for this. It is not just that once you have decided to fiddle the accounts you might as well make them look great rather than mediocre.

If you are extracting cash fraudulently, you usually need to be growing the fake earnings at a higher rate. So people who are correctly identifying frauds can often look like they are jealously attacking success. Frauds also tend to carry out lots of financial transactions and pay large commissions to investment banks, all the while making investors believe they are rich. The psychological barriers against questioning a successful CEO are not quite as powerful as those against questioning the honesty of a doctor or lawyer, but they are substantial.

And finally, most analysts’ opinions are not read. A fraudster does not have to fool everyone; he just needs to fool enough people to get his money.

If you are looking to the financial system to protect investors, you are going to end up being disappointed. But this is inevitable. Investors don’t want to be protected from fraud; they want to invest. Since the invention of stock markets, there has been surprisingly little correlation between the amount of fraud in a market and the return to investors. It’s been credibly estimated that in the Victorian era, one in six companies floated on the London Stock Exchange was a fraud. But people got rich. It’s the Canadian paradox. Although in the short term, you save your money by checking everything out, in the long term, success goes to those who trust.

The financial scandal no one is talking about

Accountancy used to be boring – and safe. But today it’s neither. Have the ‘big four’ firms become too cosy with the system they’re supposed to be keeping in check?

By Richard Brooks in The Guardian


In the summer of 2015, seven years after the financial crisis and with no end in sight to the ensuing economic stagnation for millions of citizens, I visited a new club. Nestled among the hedge-fund managers on Grosvenor Street in Mayfair, Number Twenty had recently been opened by accountancy firm KPMG. It was, said the firm’s then UK chairman Simon Collins in the fluent corporate-speak favoured by today’s top accountants, “a West End space” for clients “to meet, mingle and touch down”. The cost of the 15-year lease on the five-storey building was undisclosed, but would have been many tens of millions of pounds. It was evidently a price worth paying to look after the right people.

Inside, Number Twenty is patrolled by a small army of attractive, sharply uniformed serving staff. On one floor are dining rooms and cabinets stocked with fine wines. On another, a cocktail bar leads out on to a roof terrace. Gazing down on the refreshed executives are neo-pop art portraits of the men whose initials form today’s KPMG: Piet Klynveld (an early 20th-century Amsterdam accountant), William Barclay Peat and James Marwick (Victorian Scottish accountants) and Reinhard Goerdeler (a German concentration-camp survivor who built his country’s leading accountancy firm).

KPMG’s founders had made their names forging a worldwide profession charged with accounting for business. They had been the watchdogs of capitalism who had exposed its excesses. Their 21st-century successors, by contrast, had been found badly wanting. They had allowed a series of US subprime mortgage companies to fuel the financial crisis from which the world was still reeling.

“What do they say about hubris and nemesis?” pondered the unconvinced insider who had taken me into the club. There was certainly hubris at Number Twenty. But by shaping the world in which they operate, the accountants have ensured that they are unlikely to face their own downfall. As the world stumbles from one crisis to the next, its economy precarious and its core financial markets inadequately reformed, it won’t be the accountants who pay the price of their failure to hold capitalism to account. It will once again be the millions who lose their jobs and their livelihoods. Such is the triumph of the bean counters.

The demise of sound accounting became a critical cause of the early 21st-century financial crisis. Auditing limited companies, made mandatory in Britain around a hundred years earlier, was intended as a check on the so-called “principal/agent problem” inherent in the corporate form of business. As Adam Smith once pointed out, “managers of other people’s money” could not be trusted to be as prudent with it as they were with their own. When late-20th-century bankers began gambling with eye-watering amounts of other people’s money, good accounting became more important than ever. But the bean counters now had more commercial priorities and – with limited liability of their own – less fear for the consequences of failure. “Negligence and profusion,” as Smith foretold, duly ensued.

After the fall of Lehman Brothers brought economies to their knees in 2008, it was apparent that Ernst & Young’s audits of that bank had been all but worthless. Similar failures on the other side of the Atlantic proved that balance sheets everywhere were full of dross signed off as gold. The chairman of HBOS, arguably Britain’s most dubious lender of the boom years, explained to a subsequent parliamentary enquiry: “I met alone with the auditors – the two main partners – at least once a year, and, in our meeting, they could air anything that they found difficult. Although we had interesting discussions – they were very helpful about the business – there were never any issues raised.”

 

A new ticker about the Lehman Brothers collapse in New York in 2008. Photograph: Alamy

This insouciance typified the state auditing had reached. Subsequent investigations showed that rank-and-file auditors at KPMG had indeed questioned how much the bank was setting aside for losses. But such unhelpful matters were not something for the senior partners to bother about when their firm was pocketing handsome consulting income – £45m on top of its £56m audit fees over about seven years – and the junior bean counters’ concerns were not followed up by their superiors.

Half a century earlier, economist JK Galbraith had ended his landmark history of the 1929 Great Crash by warning of the reluctance of “men of business” to speak up “if it means disturbance of orderly business and convenience in the present”. (In this, he thought, “at least equally with communism, lies the threat to capitalism”.) Galbraith could have been prophesying accountancy a few decades later, now led by men of business rather than watchdogs of business.

Another American writer of the same period caught the likely cause of the bean counters’ blindness to looming danger even more starkly. “It is difficult to get a man to understand something”, wrote Upton Sinclair, “when his salary depends upon his not understanding it.”
For centuries, accounting itself was a fairly rudimentary process of enabling the powerful and the landed to keep tabs on those managing their estates. But over time, that narrow task was transformed by commerce. In the process it has spawned a multi-billion-dollar industry and lifestyles for its leading practitioners that could hardly be more at odds with the image of a humble number-cruncher.

Just four major global firms – Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young (EY) and KPMG – audit 97% of US public companies and all the UK’s top 100 corporations, verifying that their accounts present a trustworthy and fair view of their business to investors, customers and workers. They are the only players large enough to check the numbers for these multinational organisations, and thus enjoy effective cartel status. Not that anything as improper as price-fixing would go on – with so few major players, there’s no need. “Everyone knows what everyone else’s rates are,” one of their recent former accountants told me with a smile. There are no serious rivals to undercut them. What’s more, since audits are a legal requirement almost everywhere, this is a state-guaranteed cartel.

Despite the economic risks posed by misleading accounting, the bean counters perform their duties with relative impunity. The big firms have persuaded governments that litigation against them is an existential threat to the economy. The unparalleled advantages of a guaranteed market with huge upside and strictly limited downside are the pillars on which the big four’s multi-billion-dollar businesses are built. They are free to make profit without fearing serious consequences of their abuses, whether it is the exploitation of tax laws, slanted consultancy advice or overlooking financial crime.

KPMG abandons controversial lending of researchers to MPs


Conscious of their extreme good fortune and desperate to protect it, the accountants sometimes like to protest the harshness of their business conditions. “The environment that we are dealing with today is challenging – whether it’s the global economy, the geopolitical issues, or the stiff competition,” claimed PwC’s global chairman Dennis Nally in 2015, as he revealed what was then the highest-ever income for an accounting firm: $35bn. The following year the number edged up – as it did for the other three big four firms despite the stiff competition – to $36bn. Although they are too shy to say how much profit their worldwide income translates into, figures from countries where they are required to disclose it suggest PwC’s would have been approaching $10bn.

Among the challenges PwC faced, said Nally, was the “compulsory rotation” of auditors in Europe, a new game of accountancy musical chairs in which the big four exchange clients every 10 years or so. This is what passes for competition at the top of world accountancy. Some companies have been audited by the same firms for more than a century: KPMG counts General Electric as a 109-year-old client; PwC stepped down from the Barclays audit in 2016 after a 120-year stint.

As professionals, accountants are generally trusted to self-regulate – with predictably self-indulgent outcomes. Where a degree of independent oversight does exist, such as from the regulator established in the US following the Enron scandal and the other major scandal of the time, WorldCom – in which the now-defunct firm Arthur Andersen was accused of conspiring with the companies to game accountancy rules and presenting inflated profits to the market – powers are circumscribed. When it comes to setting the critical rules of accounting itself – how industry and finance are audited – the big four are equally dominant. Their alumni control the international and national standard-setters, ensuring that the rules of the game suit the major accountancy firms and their clients.

The long reach of the bean counters extends into the heart of governments. In Britain, the big four’s consultants counsel ministers and officials on everything from healthcare to nuclear power. Although their advice is always labelled “independent”, it invariably suits a raft of corporate clients with direct interests in it. And, unsurprisingly, most of the consultants’ prescriptions – such as marketisation of public services – entail yet more demand for their services in the years ahead. Mix in the routine recruitment of senior public officials through a revolving door out of government, and the big four have become a solvent dissolving the boundary between public and private interests.
There are other reasons for governments to cosset the big four. The disappearance of one of the four major firms – for example through the loss of licences following a criminal conviction, as happened to Arthur Andersen & Co in 2002 – presents an unacceptable threat to auditing. So, in what one former big-four partner described to the FT as a “Faustian relationship” between government and the profession, the firms escape official scrutiny even at low points such as the aftermath of the financial crisis. They are too few to fail.

The major accountancy firms also avoid the level of public scrutiny that their importance warrants. Major scandals in which they are implicated invariably come with more colourful villains for the media to spotlight. When, for example, the Paradise Papers hit the headlines in November 2017, the big news was that racing driver Lewis Hamilton had avoided VAT on buying a private jet. The more important fact that one of the world’s largest accountancy firms and a supposed watchdog of capitalism, EY, had designed the scheme for him and others, including several oligarchs, went largely unnoticed. Moreover, covering every area of business and public service, the big four firms have become the reporter’s friends. They can be relied on to explain complex regulatory and economic developments as “independent” experts and provide easy copy on difficult subjects.

Left to prosper with minimal competition or accountability, the bean counters have become extremely comfortable. Partners in the big four charge their time at several hundred pounds per hour, but make their real money from selling the services of their staff. The result is sports-star-level incomes for men and women employing no special talent and taking no personal or entrepreneurial risk. In the UK, partners’ profit shares progress from around £300,000 to incomes that at the top have reached £5m a year. Figures in the US are undeclared, because the firms are registered in Delaware and don’t have to publish accounts, but are thought to be similar. (In 2016, when I asked a senior partner at Deloitte what justified these riches, he sheepishly admitted that it was “a difficult question”.)

Targeting growth like any multinational corporation, despite their professional status, the big four continue to expand much faster than the world they serve. In their oldest markets, the UK and US, the firms are growing at more than twice the rate of those countries’ economies. By 2016, across 150 countries, the big four employed 890,000 people, which was more than the five most valuable companies in the world combined.

The big four are supremely talented at turning any change into an opportunity to earn more fees. For the past decade, all the firms’ real-terms global growth has come from selling more consulting services. Advising on post-crisis financial regulation has more than made up for the minor setback of 2008. KPMG starred in the ultimate “nothing succeeds like failure” story. Although – more than any other firm – it had missed the devaluation of subprime mortgages that led to a world banking collapse, before long it was brought in by the European Central Bank for a “major role in the asset quality review process” of most of the banks that now needed to be “stress-tested”.

The big four now style themselves as all-encompassing purveyors of “professional services”, offering the answers on everything from complying with regulations to IT systems, mergers and acquisitions and corporate strategy. The result is that, worldwide, they now make less than half of their income from auditing and related “assurance” services. They are consultancy firms with auditing sidelines, rather than the other way round.

The big firms’ senior partners, aware of the foundations on which their fortunes are built, nevertheless insist that auditing and getting the numbers right remains their core business. “I would trade any advisory relationship to save us from doing a bad audit,” KPMG’s UK head Simon Collins told the FT in 2015. “Our life hangs by the thread of whether we do a good-quality audit or not.” The evidence suggests otherwise. With so many inadequate audits sitting on the record alongside near-unremitting growth, it is clear that in a market with very few firms to choose from, poor performance is not a matter of life or death.

 

The ‘big four’ accountancy firms. Composite: Getty / Alamy / Reuters

These days, EY’s motto is “Building a better working world” (having ditched “Quality in everything we do” as part of a rebrand following its implication in the 2008 collapse of Lehman Brothers). Yet there is vanishingly little evidence that the world is any better for the consultancy advice that now provides most of the big four’s income. Still, all spew out reams of “thought leadership” to create more work. A snapshot of KPMG’s offerings in 2017 throws up: “Price is not as important as you think”; “Four ways incumbents can partner with disruptors”; and “Customer centricity”. EY adds insights such as “Positioning communities of practice for success”, while PwC can help big finance with “Banking’s biggest hurdle: its own strategy”.

The appeal of all this hot air to executives is often based on no more than fear of missing out and the comfort of believing they’re keeping up with business trends. Unsurprisingly, while their companies effectively outsource strategic thinking to the big four and other consultancy firms, productivity flatlines in the economies they command.

The commercial imperatives behind the consultancy big sell are explicit in the firms’ own targets. KPMG UK’s first two “key performance indicators”, for example, are “revenue growth” and “improving profit margin”, followed by measures of staff and customer satisfaction (which won’t be won by giving them a hard time). Exposing false accounting, fraud, tax evasion and risks to economies – everything that society might actually want from its accountants – do not feature.

Few graduate employees at the big four arrive with a passion for rooting out financial irregularity and making capitalism safe. They are motivated by good income prospects even for moderate performers, plus maybe a vague interest in the world of business. Many want to keep their options open, noticing the prevalence of qualified accountants at the top of the corporate world; nearly a quarter of chief executives of the FTSE100 largest UK companies are chartered accountants.

When it comes to integrity and honesty, there is nothing unusual about this breed. They have a similar range of susceptibility to social, psychological and financial pressures as any other group. It would be tempting to infer from tales such as that of the senior KPMG audit partner caught in a Californian car park in 2013 trading inside information in return for a Rolex watch and thousands of dollars in cash that accountancy is a dishonest profession. But such blatant corruption is exceptional. The real problem is that the profession’s unique privileges and conflicts distil ordinary human foibles into less criminal but equally corrosive practice.

A newly qualified accountant in a major firm will generally slip into a career of what the academic Matthew Gill has called “technocratism”, applying standards lawfully but to the advantage of clients, not breaking the rules but not making a stand for truth and objectivity either. Progression to the partner ranks requires “fitting in” above all else. With serious financial incentives to get to the top, the major firms end up run by the more materially rather than ethically motivated bean counters. In the UK in 2017, none of the senior partners of the big firms had built their careers in what should be the firms’ core business of auditing. Worldwide, two of the big four were led by men who were not even qualified accountants.

The core accountancy task of auditing can seem dull next to sexier alternatives, and many a bean counter yearns for excitement that the traditional role doesn’t offer. As long ago as 1969, Monty Python captured this frustration in a sketch featuring Michael Palin as an accountant and John Cleese as his careers adviser. “Our experts describe you as an appallingly dull fellow, unimaginative, timid, lacking in initiative, spineless, easily dominated, no sense of humour, tedious company and irredeemably drab and awful,” Cleese tells Palin. “And whereas in most professions these would be considerable drawbacks, in chartered accountancy they’re a positive boon.” Palin’s character, alas, wants to become a lion tamer.

The bean counter’s quest for something more exciting can be seen running through modern scandals like Enron and some of the racy early-21st-century bank accounting. One ex-big four accountant told me that if there was a single thing that would improve his profession, it would be to “make it boring again”.

Where once they were outsiders scrutinising the commercial world, the big four are now insiders burrowing ever deeper into it. All mimic the famous alumni system of the past century’s pre-eminent management consultancy, McKinsey, ensuring that when their own consultants and bean counters move on, they stay close to the old firm and bring it more work. The threat of an already too-close relationship with business becoming even more intimate is ignored. In 2016, EY’s “global brand and external communications leader” waxed biblical on the point: “You think about the right hand of greatness; actually the alumni could be the right hand of our greatness.”

The top bean counter’s self-image is no longer a modest one. “Whether serving as a steward of the proper functioning of global financial markets in the role of auditor, or solving client or societal challenges, we ask our professionals to think big about the impact they make through their work at Deloitte,” say the firm’s leaders in their “Global Impact Report”. The appreciation of the profound importance of their core auditing role does not, alas, translate into a sharp focus on the task. EY’s worldwide boss, Mark Weinberger, personifies how the top bean counters see their place in the world. He co-chairs a Russian investment committee with prime minister and Putin placeman Dmitry Medvedev; does something similar in Shanghai; sat on Donald Trump’s strategy forum until it disbanded in 2017 when the US president went fully toxic by appeasing neo-Nazis; and revels in the status of “Global Agenda Trustee” for the World Economic Forum in Davos.

The price of seats at all the top tables is a calamitous failure to account. In decades to come, without drastic reform, it will only become more expensive. If the supposed watchdogs overlook new threats, the fallout could be as cataclysmic as the last financial crisis threatened to be. Bean counting is too important to be left to today’s bean counters.

Silence from big six energy firms is deafening

If this were a competitive market, our fuel bills would be £850 a year instead of £1,100

Patrick Collinson in The Guardian


 

UK consumers are not seeing their tariffs cut despite the fall in wholesale gas and oil prices. Photograph: Alamy


You cannot hope to bribe or twist the British journalist (goes the old quote from Humbert Wolfe) “But, seeing what the man will do unbribed, there’s no occasion to.” Much the same could be said about Britain’s energy companies. You cannot call them a cartel. But seeing what they do without actively colluding, there’s no occasion to.

Almost every day the price of oil and gas falls on global markets. But this has been met with deafening inactivity from the big six energy giants. Their standard tariffs remains stubbornly high, bar tiny cuts by British Gas last year and e.on, this week.

If this were a competitive market, which reflected the 45% fall in wholesale prices seen over the last two years, the average dual-fuel consumer in Britain would be paying £850 or so a year, rather than the £1,100 charged to most customers on standard tariffs.

But it is not a competitive market. The energy giants know that around 70% of customers rarely switch, so they can be very effectively milked through the pricey standard tariff, which is, itself, set at peculiarly similar levels across the big providers. The advent of paperless billing probably helps the companies, too, with busy householders failing to spot that they are paying way over the odds.

The gap between the standard tariffs and the low-cost tariffs is now astounding – £1,100 a year vs £775 a year. Yes, the 30% of households who regularly switch can, and do, benefit. But why must we have a business model where seven out of 10 customers lose out, while three out of 10 gain?

The vast majority would rather have an honest tariff deal where their energy company passes on reductions in wholesale prices without having to go through the rigmarole of switching.

Instead, we have a regulatory set-up which believes that the problem is that not enough of us switch. It thinks that it will be solved by getting that 30% figure up to 50% or more. Unfortunately, too, many regulators have a mindset that is almost ideologically attuned to a belief in the efficacy of markets, and the benefits of competition. If competition is not working, then they think the answer is simply more competition.

What would benefit consumers in these natural monopoly markets would be less competition and more regulation. We now have decades of evidence of how privatised former monopolies behave, and what it tells us is that they are there to benefit shareholders and bonus-seeking management, rather than customers.

In March we will hear from the Competition and Markets Authority about the results of its investigation into the energy market. Maybe it will conclude that privatisation and competition have failed, but my guess is that it won’t. The clue is in the name of the authority.

• A final word about home insurance. Last week I said every insurer is in on the game, happy to rip-off loyal customers, particularly older ones. I received a letter from a 90-year-old householder in Richmond Upon Thames, who, for 20 years has bought home and contents cover from the Ecclesiastical Insurance company.

After seeing my coverage, he nervously checked his premiums, as he had been letting them go through on direct debit for years without scrutiny.

To his delight, he discovered that Ecclesiastical had, unprompted, been cutting his insurance premiums.

One company, at least, doesn’t think it should skin an elderly customer just because it can probably get away with it. We should perhaps praise the lord there is an insurer out there with a conscience.

Is Ecclesiastical the only “ethical” insurer, or are there any others who are not “in on the game”, asks our reader from Richmond. Let me know!

Opec bid to kill off US shale sends oil price down to 2009 low

Larry Elliott in The Guardian

Oil falls by $2 a barrel with energy shares as Opec refusal to stop flooding the market with cheap oil and likely US rate hike sends Brent crude tumbling

 

Oil rigs in western North Dakota, US. Opec plans not to cut output aims to kill off the threat from US shale oil by making it deeply unprofitable. Photograph: Matthew Brown/AP


Oil prices have slumped by 5% after the latest attempt by Saudi Arabia to kill off the threat from the US shale industry sent crude to its lowest level since the depths of the global recession almost seven years ago.

Signs of disarray in the Opec oil cartel prompted fears of a global glut of oil, wiping $2 off the price of a barrel of crude on Monday and leading to speculation that energy costs could continue tumbling over the coming weeks.

Shares in energy companies lost ground as the impact of the drop in oil prices rippled through European stock markets. Prices of other commodities also weakened following disappointment among traders that Opec had decided late last week to keep flooding the global market with cheap oil.

Iron ore continued its steady fall and finished the latest session at $38.90 per tonne, squeezing profit margins to the bone at even large producers such as Rio Tinto and BHP Billiton, whose shares fell sharply on the Australian stock market on Tuesday.

The consultancy Capital Economics tweeted: “#Oil sell-off after #OPEC makes even ECB look good. Better to have announced something, even if less than hoped for, than nothing at all...”

A barrel of benchmark Brent crude was changing hands for less than $41 a barrel in New York on Monday night after Opec – heavily influenced by Saudi Arabia – did nothing about a market already seen as saturated.

US light crude, which tends to trade at slightly lower levels than Brent, recorded similar falls, dropping from just over $40 a barrel to less than $38 a barrel.

Both Brent and US light crude were at levels not seen since early 2009, when the collapse of US investment bank Lehman Brothers triggered the most severe recession since the 1930s.

As recently as August 2014, Brent stood at $115 a barrel, but in 16 months its price has been more than halved in response to a slowdown in China and other emerging market economies, and the end of oil sanctions against Iran.

Global supply of oil is currently thought to be up to 2m barrels per day higher than demand, with traders fearing that Opec’s refusal to cut production despite the financial pain it is causing its members’ economies will lead to a still greater glut of crude. Venezuela, in particular, is thought to be suffering badly as a result of the drop in oil 

prices.

  Brent crude, from 2005-2015. Photograph: Thomson Reuters

The fall, if sustained, will lead to lower inflation in oil-consuming nations through the knock-on effects on petrol, diesel, domestic energy prices and the cost of running businesses.

Lower crude prices may also delay or limit increases in interest rates. The Bank of England has already accepted that inflation – which stands at -0.1% – has stayed lower for longer this year than it anticipated.

Analysts believe the slide in oil prices has come too late to persuade the US Federal Reserve, America’s central bank, to delay an increase in the cost of borrowing later this month, adding that the prospect of the first tightening of policy from the Fed since 2006 was an added factor in crude’s decline.

The prospect of higher US interest rates has led to the value of the US dollar rising on foreign exchanges; since oil is priced in dollars that has led to a fall in the cost of crude.

Markets had been expecting Opec to announce a new ceiling on production after last Friday’s meeting, but analysts at Barclays said the lack of any curbs in its announcement was a sign of discord.

“Past communiques have at least included statements to adhere, strictly adhere, or maintain output in line with the production target. This one glaringly did not,” they said.

Saudi Arabia needs oil prices of $100 a barrel to balance its budget, but as the world’s biggest exporter of crude it is gambling that the low price will knock out the threat posed by so-called unconventional supplies, such as shale.

The chief executive of Saudi Aramco, Amin Nasser, said at a conference in Doha on Monday that he hoped to see oil prices adjust at the beginning of next year as unconventional oil supplies start to decline.

In a sign that US production could dip, Baker Hughes’ November data showed US rig count numbers down month-by-month by 31 to 760 rigs.

The fall in oil prices helped wipe almost 1% off share prices in New York. Wall Street’s Dow Jones industrial average was down more than 160 points in early trading, with Chevron and Exxon both losing around 3% of their value.

In London, Shell’s share price was down 4.5% while BP lost 3.4% of its value as early gains in the FTSE 100 were wiped out. The Index closed 15 points lower at 6223.

Paralysed Opec pleads for allies as oil price crumbles

Ambrose Evans-Pritchard in The Telegraph

The Opec cartel is to continue flooding the world with crude oil despite a chronic glut and the desperate plight of its own members, demanding that Russia, Kazakhstan and other producers join forces before there can be output cuts.

Brent prices tumbled almost $2 a barrel to $42.90 as traders tried to make sense of the fractious Opec gathering in Vienna, which ended with no production target and no guidance on policy. It reeked of paralysis.

Prices are poised to test lows last seen at the depths of the financial crisis in early 2009. The shares of oil companies plummeted in London, and US shale drillers went into freefall on Wall Street.

Oil tankers are lined up off the cost of Texas, a flotilla of crude storage across the world  Photo: Alamy

“Lots of people said Opec was dead. Opec itself has just confirmed it,” said Jamie Webster, head of HIS Energy.

Venezuela’s oil minister, Eulogio del Pino, pushed for a cut in output of 1.5m barrels a day (b/d) to clear the market, describing the failure to act as calamitous. “We are really worried,” he said.

Abdallah Salem el-Badri, Opec’s chief, conceded that the cartel’s strategy has been reduced to an impotent waiting game, hoping that the pain of low prices will lure Russia and other global producers to the table. “We are looking for negotiations with non-Opec, and trying to reach a collective effort,” he said.

Mr el-Badri said there have been “positive” noises from some but none is yet ready to lock arms and create a sort of super-Opec, able to dictate prices. “Everybody is trying to digest how they can do it,” he said

The cartel’s 12 members postponed a decision on their next step until next year, once they know how much oil Iran will sell after sanctions are lifted. “The picture is not really clear at this time, and we are going to look one more time in June,” he said.

“Everybody is worried about prices. Nobody is happy,” said Iraq’s envoy, Adel Abdul Mahdi. His country has lost 42pc of its fiscal revenues and is effectively bankrupt.

Foreign companies are owed billions and have begun to freeze projects. The government cannot afford to pay its own security forces and is cutting vital funding for anti-ISIS militias, raising fears that the political crisis could spin out of control.

Helima Croft, from RBC Capital Markets, said four of the frontline states in the fight against ISIS are now being destabilized by the crash in oil prices, including Algeria and Libya.

Opec leaders will now have to grit their teeth and prepare for a long siege, testing their social welfare models to the point of destruction. Even Saudi Arabia is pushing through drastic austerity measures.

Deutsche Bank said the fiscal break-even cost needed to balance the budget is roughly $120 for Bahrain, $100 for Saudi Arabia, $90 for Nigeria and Venezuela, and $80 for Russia, based on current exchange rate effects.

“It is going to be 12 to 18 months before they see any relief,” David Fyfe, from the oil trading group Gunvor, said.

“We think oil stocks will continue to build in the first half of next year and we don’t think they will draw down to normal levels until well into 2017.”

Mr Fyfe said Iran has 40m to 50m barrels floating on tankers offshore that will flood onto the market as soon as sanctions are lifted. It will then crank up extra output to 500,000 b/d by the end of next year.

Per Magnus Nysveen, from Rystad Energy, said it will take a very long time to force the capitulation of America’s shale industry. While the rig count in the US has collapsed by 60pc over the past year, the number of wells being “fracked” has risen in recent weeks.

“There is still an inventory of 3,500 wells. Theoretically they could continue fracking at this pace for another six months without any new drilling. We don’t think there is going to be a significant fall in US output next year. It could be flat,” he said.

Mr Nysveen said the damage will be in other parts of the world, chiefly the mature offshore fields in the Gulf of Mexico, North Sea, Brazil and Africa. The decline rate of old fields will double to 10pc a year, subtracting 750,000 b/d from world supply within 12 months.

It is going to be a long war of attrition. The world is awash with oil. US crude inventories rose further last week by 1.6m barrels to the vertiginous level of 489.4m.

China has been soaking up some 250,000 b/d for its strategic reserves, preventing a collapse of the market. But the old sites are filling up and it is unclear whether new facilities are ready.

OPEC is now just as irrelevant as the once mighty Texas Railroad Commission

More than 100m barrels are being stored on tankers offshore. Tanker day-rates have soared to more than $111,000 – the highest since July 2008 – as the last remaining vessels are booked to absorb the glut.

Goldman Sachs warns that the market is approaching an “inflexion point” that could send prices crashing to a new a floor of $20, the "cash cost" that forces drillers to stop production altogether.

A dangerous situation is developing. Opec policy has caused spare capacity to fall to a wafer-thin margin of 2m b/d, leaving no one to act as the regulator of the market.

This sets the stage for a violent spike in prices down the road. The International Energy Agency says the world needs $650bn of fresh investment each year in upstream oil and gas just to stand still, yet $240bn has already been slashed from projects earmarked for next year.

Bhushan Bahree, from HIS Energy, says there is no longer anything to distinguish Opec members from any other producer. The cartel is defunct. “Opec and non-Opec are irrelevant classifications,” he said.

There is a new world order of three oil superpowers with roughly equal shares – Saudi Arabia, Russia and the US – and none of them is yet willing to cut output voluntarily to shore up prices.

The Americans would never agree to such a move. The Russians cannot easily do so, given that their key producers are listed-companies, supposedly answerable to shareholders, and Siberian conditions make it hard to switch output on and off. The Saudis are stuck.

Mr Bahree compares the demise of Opec with the fall of the Texas Railroad Commission, the once mighty giant that set output and controlled world prices through the middle years of the 20th century. The Commission still exists, a forgotten shadow of its former self. Today it issues local permits.