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The Hard Floor in Oil

By Matt Badiali, editor, S&A Resource Report
Friday, October 6, 2006

Saudi Arabia’s state-owned oil company is 20 times larger than ExxonMobil...
At least that is what an NPR “Morning Edition” interview reported last week. It’s hard to gauge the size of state-owned oil companies, such as Saudi Aramco, because they’re so darn secretive. Unlike our Majors, whose business is at least semitransparent, state-owned firms are black boxes to most of us.
That would be fine, except that these nationalized oil companies make up the most formidable cartel in the world... OPEC.
OPEC is like any governmental organization. Once it has gotten its hands on extra cash, it is highly unlikely to give it back. This year, OPEC found that the world – especially the U.S. – could function at very high oil prices.
Just how well are high-energy prices treating our friends in OPEC? Well, the Middle East alone has reaped about $400 billion from oil sales in 2006.
The Washington Post says you can see the results of that extra income in Dubai:
“The pace of development in Dubai makes you dizzy: This tiny country is planning the world’s tallest building, the world's biggest shopping mall, the world's largest fleet of jumbo airplanes. It is building a $4.3 billion World Trade Center, an $11 billion Festival City, a $10 billion theme park known as Dubailand. One measure of the boom here is that the real estate listings in Monday’s Gulf News ran to 148 pages.”
OPEC countries got used to the padded margins. What are they going to do now, scrap Dubailand? I doubt it. I expect OPEC to curb the fall in oil prices anytime now.
My original thesis in this essay wasn’t so much that OPEC is a massively rich clandestine organization that wants to subvert every aspect of energy to further its own ends.
It was rather that OPEC is a massively rich, clandestine organization that, once it tasted $60+ per barrel, is eager to return to it. In fact, we’re already seeing production cuts from OPEC’s “rogue members.”
The production cutback scenario will probably go something like:
Rogue members such as Venezuela and Iran band together to sway the more “moderate members,” such as Saudi Arabia, to curb production. The original proposal will begin with ridiculous cuts, and the “pro-U.S.” members will moderate them. Then, when they meet with our outraged State Department folks, they can throw up their hands and say:
“We did all we could, they wouldn’t be swayed. At least we reigned them in a bit.”
The result will be a hard bounce back from the high $50s per barrel into the mid-$60s. Analysts who predicted $40-per-barrel oil are looking at a remote possibility, just like those who predicted $100-per-barrel oil.
We’ve seen the initial stages of this scenario play out this week, with OPEC members, including Nigeria, Indonesia, and Saudi Arabia, getting behind production cuts. Oil prices are responding, and I expect them to stay strong on some new (and media-hyped) fear.
The take-home message is: Don’t worry about the possibility of free-falling oil prices; OPEC will set a hard floor. After all, who doesn’t want to take the family to Dubailand?
Good investing,
Matt Badiali

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Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%