Tag Archives: OPEC

will OPEC cap its oil output?

September 29, 2016 By in oil and natural gas, Saudi Arabia, Uncategorized Tags: , , , , , , Leave a comment

…maybe, for a short while anyway.   Ultimately, no.

Will this move shore up oil prices?

…probably not.

Yesterday OPEC announced a provisionary agreement according to which the oil cartel’s members will limit aggregate output to between 32.5 million barrels per day and 33.0 million.  At the lower end, that would remove 750,000 daily barrels (or 2.3%) from OPEC production.  According to the Financial Times, virtually all of the reduction would be by Saudi Arabia; other OPEC members promise only not to increase theirs.

Saudi Arabia has previously been dead set against any agreement of this type.  Why?   During the early 1980s oil glut, the Saudis sliced oil liftings from 13 million barrels daily to 3 million in a vain attempt to stabilize prices.  That effort failed because everyone else in OPEC cheated, boosting their output to fill the void.

That such cheating happens shouldn’t come as a shock.  It’s standard cartel behavior–and the reason most cartels fail.  The truly startling development in the modern history of commodity-producing cartels was the solidarity of OPEC in its formative years, when it was a political cartel opposing exploitation of third world countries.  It has lost its power as it evolved into the current economic one.

So, as I see it, there’s no reason not to expect widespread cheating again.

Another factor arguing against this agreement actually stabilizing crude oil prices is that OPEC doesn’t dominate world oil production as it did in the 1980s.  Four of today’s top six oil-producing countries (Russia, US, China, Canada) are not members of OPEC.  There’s every reason to expect that all of the four would boost output as/when prices start to rise.

 

To my mind, the real news the OPEC accord signals is the changed attitude of Saudi Arabia.  I think this must mean that Riyadh is in worse financial shape than is commonly believed.

Certainly, the country is radially dependent on oil   …and has become accustomed to the revenue from  $100+ per barrel prices.  So it is now running a large government budget deficit.  My guess is that it is also having a much harder time than expected in borrowing to bridge the gap between revenue and spending, and that efforts to develop other facets of the economy are not moving forward smoothly.  Saudi Arabia has just announced a salary cut for government workers, which can’t imply greater political stability.

If there is a valid reason for oil to have risen on the OPEC announcement–and I don’t think there is–it would be worries of political developments in Saudia Arabia that disrupt oil production there.

Personally, not owning any oil stocks at present, I’m thinking that the seasonal low point for demand, that is, January/February, would be a better entry time than right now.

Shaping a Portfolio for 2016: petrodollars

December 10, 2015 By in oil and natural gas, shale oil, Shaping a Portfolio for 2016, Uncategorized Tags: , , , , , 1 Comment

Petrodollars is the term coined in the 1970s to describe the money flow from oil consuming nations to oil producers–meaning by and large OPEC–during a decade when the crude oil price skyrocketed from around $3 a barrel in 1970 to $25+ in 1979.

Some economists of the day feared that this massive increase in money paid for fuel would be, in effect, withdrawn from circulation in the global money supply, and that the resulting money supply contraction could cause a worldwide recession.  (I have no idea where this notion came from, but it was seriously discussed.  Another strange idea being floated then was of the “backward-bending demand curve,” i.e., that there was something magical about oil so that the higher the price went, the more demand increased.)

What happened instead was that these funds were quickly recycled into the world money supply through increased spending by OPEC and through gigantic purchases of financial and other assets, from Treasury bonds to real estate to large stakes in publicly listed companies in Europe and the US.

Economic growth in the OECD did slow markedly during the 1970s and inflation rose sharply in places like the US, as industry heavily reliant on ultra-cheap oil struggled to adjust.  One might also argue that the fact that money was going from the pockets of avid consumers to those of wealthy savers also retarded economic expansion.

What I’ve just written is only interesting, other than to me, because the reverse of that 1970s flow is now happening.  More money is remaining in the hands of consumers.  According to the Financial Times, during the September quarter alone, Middle Eastern sovereign wealth funds cashed in at least $19 billion of their investments to underpin current government spending. Since not all asset manager report withdrawals, the true figure could easily be twice that.

It’s clear that a large shift of wealth away from OPEC and to oil consumers is under way.  But, in addition, as OPEC liquidates financial investments to fund current spending–Saudi Arabia is actually talking about issuing international bonds to fund its budget deficit–it will provide another monetary (and consumption) tailwind for economic growth in 2016.

more on oil

August 4, 2015 By in emerging markets, Energy, Industry Analysis, shale oil Tags: , , , , , , , , 1 Comment

As I was thinking about this post, I knew that oil is a complicated subject and that there’s a risk of getting lost in the details.  So I decided to sketch out the structure of the post carefully on paper before I began to write.  Several pages of notes later, I abandoned the attempt, in favor of extreme simplicity (I hope).

oil

Like any other mineral commodity, oil is subject to boom and bust cycles.  We’re now in bust, meaning that supply is structurally higher than demand, exerting continuous downward pressure on prices.

As with any other commodity, prices will stay low until supply and demand come back into balance.  The slow way for this to happen is for demand, now at about 93 million barrels per day and growing at 1%+ per year, to expand.  The fast way is for prices to stay low enough, long enough for high-cost producers to go out of business.  As I see it, adjustment will primarily come the fast way.

Oil is peculiar, though, in two respects, both of which argue that prices will stay low for a considerable time:

–many major oil producing countries (e.g., the Middle East, Russia) have relatively simple economies that are radically dependent on exports of oil for government income.  Over the past year, OPEC oil output has actually risen by about 1.5 million barrels per day, despite the expanding glut.  This indicates that, unlike prior periods of oversupply, the group has no desire to try to moderate the downturn.

–the long-term geological damage to a big oilfield from turning the taps off and on can be great.  So producers are more hesitant than in other industries to do so.

the catalyst

Arguably, what has upset the pricing applecart is the unanticipated surge in oil production in the US, which was 5.6 million barrels per day this time in 2011 and is 9.5 million today.  Hydraulic fracturing is the reason for this.

where to from here?

US oil production is still averaging more than a million barrels per day higher than in 2014.  However, the steady month by month march upward of output figures may have been broken in May, when liftings were about 200,000 barrels a day less than in April.

My guess (and I’m doing little more than plucking numbers out of the air) is that at $50 a barrel or below, new fracking projects won’t get started. Under $40 a barrel, some wells may be shut in.  If a production falloff comes solely through the former mechanism, we’re probably a year away from a meaningful (translation:  more than a million barrels, but after that, who knows) decline in fracking output.

That would likely mean a higher oil price then than now, IF (…a big “if”) OPEC nations desperate for cash don’t up their production further.

what I’m doing

I have no desire to buy oil stocks today, because I think we’re not that far along in getting supply and demand back into balance.  In the early 1980s, for example, the entire process from top to bottom took about half a decade.  I’m also thinking that there might either be another sharp price decline, or simply a further sharp selloff in oil stocks before the current oversupply is over.  I’ve just started to think about what I might buy if either were to happen.  One thing is certain, though.  It won’t be the big oils, or tar sands, or LNG.

more than you ever wanted to know

When I started on Wall Street as an oil analyst, oil and natural gas sold for roughly the same price per unit of heating power.  Natural gas has been less than half the cost of oil on a heating equivalent basis for many years, however, because it isn’t in widespread use as a transportation fuel and because it takes a pipeline to deliver it to customers.  Natural gas is already being substituted for coal in power generation.  Will it ever have a dampening effect on the ability of the oil price to rise?

which is the better question: where is the oil price floor or where is the ceiling?

February 19, 2015 By in Current Market Thoughts, Energy, Industry Analysis, shale oil Tags: , , , , , , Leave a comment

I read sports for a radio station for the blind each Thursday.  I was listening, as usual, to Bloomberg radio in my car while on the way.  I caught the tail end of a conversation in which a guest was apparently trying to explain the difference between a copper mine (a multi-billion dollar, multi-year project) and a shale oil well ( up and drilling for cheap in a month or two).  This came as a revelation to the show’s hosts.  Part was probably showmanship, but it also underlined to me how little knowledge about mining and basic materials industries survives on Wall Street.

A basic rule of any commodities business (regular readers will know I spent six years as an oil and mining analyst and another couple managing money in stock markets with large commodity exposure) is that in times of oversupply the price only stabilizes when it falls (and remains) below the out-of-pocket costs of the most expensive producers.  The bottoming process may take a surprisingly long time.  That’s because producers may choose to operate at a loss for a while, if the costs of starting up again are high (think:  blast furnace steel) and the oversupply is perceived to be temporary.

–In the case of oil, Saudi Arabia is doing all it can to convince the world that the oversupply is not temporary.  That’s one worry out of the way.

–The consensus belief is that the floor is around $40.

Presumably this information is being factored into today’s stock prices.  Therefore, it isn’t so interesting.

the ceiling

The better question, I think, is how high the oil price might go once high-cost supply has left the market.

base metals

For a base metals mining project, reassembling a crew + machinery to restart a shuttered mine is expensive and may take half a year.  And certainly no one is going to begin to develop a new mine until price visibility is very high.

shale oil

For shale oil, on the other hand, startup might only require a handful of people and maybe a month.  In addition, if I thought I could get, say, $70 a barrel for my oil a year or two down the road instead of $45 today, I’d deliberately pull at least some of my wells out of production and wait–assuming I had my debt repayments under control.  For that portion of my output, I’d be ready to turn the spigot instantly.

I don’t know exactly what price level triggers a return of shale oil to the market, creating potential oversupply again.  But production will return very quickly.

The trigger is clearly not as high as $100.  If I were analyzing oil companies for their rebound potential, I’d hope for $70 but base my figures on $60.  The analysis itself would tell me whether $60 is high enough.

My general conclusion, though, is that oil isn’t going back to the levels of a year ago for a long time.

an aside

The best petroleum economists in the world are in OPEC.  It’s impossible that Saudi Arabia doesn’t know with much greater precision what I’ve been writing about.  Why should it be talking of oil at $100 or $200 in the near future?

Maybe for public consumption at home.  A more devious mind would suggest it’s to persuade lawmakers in the US, the most profligate user of oil, not to take the sensible course of raising gasoline taxes and thereby tempering future demand increases.  The country’s lobbyists are doubtless hard at work in Washington, as well.

oil: how the price dynamic has changed

February 4, 2015 By in Current Market Thoughts, Energy, Industry Analysis, oil and natural gas, shale oil, Strategy Tags: , , , , , , , Leave a comment

Value Line vs. O”Neil

My first Wall Street job was with Value Line, a firm which has seen better days but which dominated the retail market for investment information in the 1970s – 1980s.  It still publishes the Value Line Investment Survey, a newsprint weekly that over a 13-week cycle provides historical data, analyst commentary (generally not good nowadays) and a computer-generated comparison of relative investment attractiveness (based on PE and earnings growth) for a universe of around 1800 stocks.  As I recall, the Survey cost about $250 a year back then and had about 80,000 subscribers.

Analysts and portfolio managers who worked for the company couldn’t understand why the price was so low.  We all thought the publication should sell for at least double the going price.  Since the main costs of publication were for printing and postage (sadly, not for salaries), the company could triple or quadruple its profits by charging $500.  The publication was surely worth it.  Yet the firm’s owner adamantly refused to budge.  A real head scratcher.

Then we found out why.

A rival emerged in the form of William O’Neil and Company, a suppliers of very detailed price charts and other technical information to individuals and institutions. O’Neil launched a chart-based weekly service covering the same universe of stocks, cpriced at $125 a year.  No analysis, but similar historical data, loads of technical information and highly detailed charts that put Value Line’s to shame.

The publication lasted about a year and then folded (I Googled O’Neil just before writing this.  The firm appears to have revived the idea and to now be selling a similar service.  I didn’t investigate, though.)

Why?

I remember figuring at the time that O’Neil needed at least 5,000 subscribers to be cash flow positive (this was a long time ago, so my numbers may be way off.  Their accuracy isn’t necessary for my point, though.).  If it got there, it could gradually add features and increase marketing   …and start to grow itself into a serious competitor to Value Line.  O’Neil couldn’t get north of 2,000 with its service, however, and quickly got tired of bleeding red ink.

Suppose the VLIS had been priced at $500 instead of $250?  O’Neil could have priced his service at, say, $250   …or even $350 and still offered a generous discount.  At 2,000 subscribers he would have been in the black–and growing into an increasingly sharp thorn in Value Line’s side.

The clear economic response to this development would have been for VL to cut its price to $250 to make O’Neil unviable.  But that would have been psychologically very hard to do.  It would have created internal morale problems as belt-tightening took hold.   And it might also draw the attention of the Justice Department.  Waiting two or three years, hoping (in vain) for the competitive dynamic to change, would only compound the problem.

pricing umbrella

That was my introduction to the concept of a pricing umbrella, the idea that high margins creates a fertile, sheltered environment in which competition can grow.

why it’s bad

Two negative consequences:

–competition can gain critical mass, and

–even if it can’t, if newcomers have made significant capital investment they will continue to operate–at a loss–to extract whatever cash they can from their failing businesses.

OPEC’s umbrella

More or less, this is the messy situation that OPEC has created in the oil market.

Under the protection of a $100 a barrel price, unconventional, technology-based competitors have emerged, mostly in the US so far.  This happened about half a decade ago.  The newcomers were initially able to extract oil profitably at $80 a barrel (as opposed to less than $10 for Saudi Arabia).  But they’ve improved their techniques to the point that many can make money at $40.

results of the oil price halving

In the near term, highly financially leveraged high-cost oil producers will be forced by their creditors to stop spending on new projects.  They will continue to produce from existing wells until they run dry, however.  It’s just that all their cash flow will be devoted to repaying debt.

The long-term problem for OPEC is that the new technology–whose development high prices stimulated–won’t go away.  As/when prices rebound to, say, $60 a barrel, hydraulic fracturing will begin to expand aggressively again.  I think shale oil output will rise relatively quickly, as solvent oil development firms take over in-the-ground infrastructure left idle by their bankrupt brethren.

At some point, the oil price will bottom.  I don’t know whether that point is now or not, but I’ve been thinking that something like $40 a barrel will be the floor.  On the other hand, I don’t see the market returning to the status quo ante within any reasonable amount of time.

How this affects oil stocks tomorrow.