Friday, June 19, 2015
The financial media and many Wall Street analysts are missing the big picture in oil right now...
The U.S. is the world's leading oil producer... so the U.S. oil market is what everyone is focused on. But we don't lead the global oil market. OPEC (the Organization of the Petroleum Exporting Countries) does.
And OPEC is playing a global game of oil-price "chicken" right now...
As regular readers know, the price of oil collapsed 60% from June 2014 to March 2015. And for the first time in nearly 30 years, OPEC – the oil cartel that has effectively set the oil price for decades – didn't step in to prop up oil prices by cutting production. Instead, it's going to let production fall naturally.
You see, the average price of Brent crude (the world's benchmark) from 2010 to 2014 was $102 per barrel. That's a 43% increase from 2007. At that price, expensive oil all over the world became economic – miles deep under the ocean, under the frozen seas of the Arctic, and even trapped in shale rock. Companies could afford to spend money figuring out the science to extract it because the economics were fantastic.
Thanks to sustained high oil prices, a gush of new, costly oil came on the market. But the world's economies didn't need it. This sent oil prices plummeting... and gave OPEC an opportunity. It could choose to prop up oil prices... or it could let them fall.
Letting the oil price fall is OPEC's way of thinning the herd on expensive oil projects... and it's causing a decline in global investment. According to analysts at Morgan Stanley, global spending on oil and gas production is down 25% in 2015 from 2014.
It's now too expensive to invest in Canada's tar sands, the North Sea, offshore Africa, offshore Brazil, and northern Iraq's oil fields. These oil fields hold huge amounts of oil, but they need billions of dollars in wells, pipelines, storage tanks, and other infrastructure to develop.
And while we have more than enough oil today, it will take an enormous amount of investment to meet global demand over the next 15 years. You see, oil demand is growing in less-developed countries like Brazil, China, and India.
According to the International Energy Agency, "the United Nations of energy," some $900 billion per year in upstream oil and gas exploration development is needed by the 2030s to meet projected demand.
By sending oil prices down and keeping them there, OPEC is ensuring that the investments we need for the future aren't happening. Without these investments, oil prices will head higher. This is exactly what OPEC wants...
Without these investments, OPEC countries will continue to be the world's leading oil producers. They will be able to control oil prices for the next decade or two.
They know, because they've done it before...
From 1979 to 1981, shrinking production plus a spike in demand sent oil prices skyrocketing 150%. But high oil prices sparked new production outside the OPEC countries. Giant field discoveries, like Alaska's Prudhoe Bay and the North Sea off the shore of Scotland, came online. And high oil prices, combined with a recession in the U.S., Canada, and the U.K., pushed demand down.
More supply and less demand should have sent prices down... But OPEC members had gotten used to the rich income that high oil prices generate. They couldn't let them fall. So the oil cartel – led by Saudi Arabia – slashed production to help prop prices up. Saudi Arabia alone cut production from 10 million barrels per day in 1980 to 2.3 million barrels per day by 1985.
However, this didn't work out the way Saudi Arabia expected... the reduced production crushed the country's income. Oil revenue fell from $119 billion in 1982 to $26 billion in 1985.
In August 1985, Saudi Arabia declared itself done with the role of oil-price supporter. Instead of keeping production capped, it opened the spigots. Oil prices fell 58% in just seven months.
This was a dramatic shift in strategy for the Saudis and OPEC. Instead of trying to protect the price of oil, they decided to go after market share.
Saudi Arabia has the lowest-cost oil in the world. So while profits would decline for a while, Saudi Arabia's leaders knew they could withstand a year or two of low oil prices. But the industry couldn't... High-cost producers and companies loaded with debt would die off quickly. And the big companies would cut investment in new projects to save cash.
Oil is an industry that needs enormous investment for future production. The fewer dollars going into the ground today, the less oil that will come out tomorrow.
Saudi Arabia's strategy pruned back the new, expensive oil projects around the world. In North America, the falling price cut oil production by 8% from 1985 to 1990. The U.S. saw a 14% decline in production between 1985 and 1990. And OPEC recovered its market share.
U.S. imports from OPEC nations soared from just 3.2 million barrels per day in 1985 to 9.1 million barrels per day by 2000. In 1985, OPEC supplied just 41% of U.S. crude-oil imports. By 1990, it supplied 60%.
Saudi Arabia's strategy worked so well that OPEC's share of the oil market is actually higher today than it was in 1985 – 39%, compared with 30%.
The Saudis are dumping oil into the market today for the same reasons they did it in the 1980s... They want to cling to their market share and continue to control oil prices.
Saudi Arabia is sitting on $757 billion in cash and investments in a state-owned fund filled with excess oil profits. It can afford to wait out low oil prices.
But at the current pace of cuts in investment and production, it may not have to wait long.
With oil demand set to increase and investment in future oil production decreasing, we'll likely see oil prices head higher over the next few years. The move won't be straight up. And we could see prices fall this year before recovering.
But they will recover... This is a situation we'll be keeping a close eye on.
With oil prices down and production soaring, "there's an anomaly in the oil sector today," Brian Weepie writes. "And it's creating a great opportunity for resource investors." Learn how you can profit right here.
If you plan to invest one dime in natural resources, this classic interview with master resource investor Rick Rule is a must-read. In it, he reveals everything you need to know to master the resource market's cyclicality. If you catch one of these big cycles at the wrong time, you can lose a fortune. But if you catch one early, you may never have to work again...
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