Below, we offer a little history and a discussion of the current impact of lower oil prices on the world economies, as well as our thoughts on the industries and companies that will be benefitted by the new lower oil prices.
Since 1973, the Organization of the Petroluem Exporting Countries (OPEC) has largely controlled the price of oil. The members, including countries such as Nigeria, Saudi Arabia, Venezuela, and Iran, may not have liked each other, but they agreed to keep the price in line. Since they were by far the world’s most prolific oil producers, such control was within their power. Two big oil producers, Canada and Russia, do not belong to OPEC.
Even though the U.S. has been a big producer of oil, it consumes more than it produces. Thus, the U.S. is and has been a major importer of foreign oil for decades. However, U.S. imports have been falling fast for the last few years.
Saudi Arabia, the world’s biggest producer, was also the most diplomatic, often taking pressure on their oil revenues to keep the cartel going. They have recently decided to teach their fellow OPEC members and Russia a lesson by allowing the price to fall, so that oil will be unprofitable to produce except in the world’s lowest-cost fields.
Saudi Arabia’s Current Goals
For public consumption, the Saudis must say that they want to stop U.S. shale oil producers from creating so much new production. In reality, that goal is only a minor part of the Saudi agenda. They have a much more important goal, which is to punish and politically enfeeble Iran and Russia.
Iran is their neighbor and their bitter enemy, and a country that has repeatedly stated that they want to destroy the Saudi regime. Russia, for its part, has supported Middle Eastern regimes which want to destroy Saudi Arabia.
Global Supply and Demand Balance
During the past decade and a half, demand from China, India, and other emerging nations has been strong, as these countries have become more wealthy. Demand continued to be strong from the U.S., Japan, and Europe.
Since 2000, new oil supply has not been growing as rapidly as demand. Globally, only a few moderate-sized conventional fields have been discovered. In fact, Nigeria, Mexico, and Venezuela have seen oil production decline.
After 2010, the peak oil thesis argued that world oil production had peaked, and that prices had to rise a great deal to handle demand. This theory has been rendered obsolete by technology.
Our readers know that oil prices around $100 per barrel gave Canadian tar sands production a profitable opening, and that strong prices led to the ongoing shale oil production boom. The technology which led to the shale revolution was horizontal drilling and fracturing (fracking), which we have explained in prior letters. Of course, these technologies are not static, but are constantly being refined and improved.
As a result, U.S. oil production ramped up dramatically many years sooner than most analysts expected. As the U.S. has grown nearer to self-sufficiency, OPEC sales to the U.S. have declined, and this has precipitated a price war within OPEC.
The overall oil market was dominated by strong demand from the emerging world until about mid-2014, when it became obvious to all alert market participants that world supply had exceeded world demand and that a glut had been formed, and that oil prices would subsequently fall.
Clearly, the last several months have proven that oil prices are not going to bottom at $80 or $70 per barrel as the hopeful had expected.
Oil prices are in a free fall, and we at GIM anticipate that U.S. domestic oil prices will reach $50 per barrel before it is all over. At $60 per barrel, producers will start to cut back a lot of their production. Prices will eventually rise and probably level off at about $60 to $80 per barrel over the longer run.
Today, oil prices are lower and more volatile than we have seen for years. It is also very clear that OPEC is no longer able to control world oil prices. Too many hatreds and too many differing goals for OPEC membersmake an accommodation and cooperation within the cartel look highly unlikely.
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