₦airaland Forum

OPEC is not going to come to the rescue. It is up to American producers to cut oil supplies.

The world freaked out over oil Monday. U.S. crude fell as low as $49.77 a barrel, down about 6%. Brent crude is at $53. This is the lowest price since early 2009, when oil bottomed at $35 less than nine months after hitting a record high of $147.

The Dow Jones Industrial Average fell 331 points Monday. Many reports have blamed oil for the stock market weakness, but that doesn’t really make much sense. All else equal, low oil prices are a boon to economic growth. And besides, considering how high the Dow has risen, 330 points just ain’t what it used to be — merely a 1.8% move. Back in 2008 the Dow suffered 11 days with losses of 4% or more.

Indeed, it’s the pain being borne by energy investors that is dragging down the market. Energy makes up about 10% of the large-cap universe. Yesterday the average energy company was off 4%. Weaker, debt-saddled companies fared far worse. Swift Energy was down 18%, SandRidge Energy fell nearly 13% and Halcon Resources lost 10%.

When a commodity falls 50% in price so quickly, bargain hunters emerge. On Monday a self-described “degenerate gambler” and Forbes staffer asked if now was the time to take a flyer on USO — the United States Oil Fund exchange traded fund that ostensibly tracks oil prices — in expectation of an eventual upturn.

No, I told him. Don’t buy USO. In fact, if I’m going to bet on oil, that ETF is the last thing I’d buy. It makes far more sense to buy shares in the companies that produce it, for the simple reason that a leveraged commodity producer’s earnings modulate with a greater amplitude than the swings in the price of their underlying commodity. In other words, oil company shares tend to be more volatile than oil itself.

Look at the five-year or 10-year chart on the USO fund, and compare it with those of three champions of the American oil boom: EOG Resources EOG -4.35%, Pioneer Natural Resources PXD -1.28%, and Continental Resources CLR -4.1%. In good times the ETF has lagged on the upside. And in bad times, like recently, it has lost even more than those other companies’ shares.


If you’re thinking about buying into this market, you want to own well run companies with low-cost core acreage in the best oil fields. Because once this era of oil price volatility is over and the market returns to a new normalcy it will be American tight oil producers that assume the role of “swing producers,” bringing stability to the market.

http://www.forbes.com/sites/christopherhelman/2015/01/06/investors-freak-as-saudi-inaction-could-sink-oil-to-20-a-barrel-time-to-buy

Much of the value of these American companies is in their flexibility to tailor their drilling programs to prevailing prices. It used to be that big oil companies had to invest billions of dollars over several years in massive projects before they could start getting oil out of the ground. But the shale oil boom has changed that. These companies, and many others, now have lots of options and can quite quickly ramp up or dial back drilling operations in response to prices.

It used to be that OPEC controlled the world oil market while Saudi Arabia was the designated swing producer. But with the rise of new American oil, that has changed. Henceforth, it will be American oil producers that supply the world’s marginal, high-priced barrels, and American producers that will need to have the discipline (without collusion of course!) to keep from over drilling.

This reality hasn’t quite been accepted by oil companies still waiting for OPEC to take action and cut its own production. Which is why oil prices (and stocks) likely have another big leg down from here.

How far? At least $40. Maybe even $20.

But don’t take my word for it.

Two weeks ago, while most of us were getting merry and happy, the Middle East Economic Survey landed an exclusive interview with Saudi oil minister Ali Naimi. (I encourage everyone with an interest in oil markets to read the full interview for free here.)

In the interview, Naimi said in no uncertain terms that neither the Kingdom nor OPEC has any intention to cut production. He said that Saudi production costs are no more than $5 per barrel, and that marginal costs of development are “at most” $10 per barrel.


Thus, Naimi said, “As a policy for OPEC, and I convinced OPEC of this [...] it is not in the interest of OPEC producers to cut their production, whatever the price is.” He added: “Whether it goes down to $20, $40, $50, $60, it is irrelevant.”

Naimi declared that this is absolutely a battle for market share. It’s unfair, he said, to expect OPEC, the lowest-cost producer, to reduce output, when there are so many higher cost barrels in the world especially on the margins of America’s tight oil plays. Some U.S. shale oil is economic at $20, he said, but much more requires $80.

Said Naimi: “Is it reasonable for a highly efficient producer to reduce output, while the producer of poor efficiency continues to produce? That is crooked logic. If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, U.S. shale oil producers will take my share.”

Oil companies worldwide have already cut their capital spending and drilling budgets. Considering that conventional oil fields decline in production by about 6% a year, on average, while shale oil wells decline 50% in their first 6 months, it is only a matter of time before supply and demand come back into balance.

There could be a lot more pain before then because many cash-strapped petro-states and highly leveraged oil companies need all the dollars they can get, regardless of how much oil they need to sell to get it.

Iraq’s output is growing fast and will keep growing because Baghdad (and Erbil) need cash to defend and rebuild their country.

Likewise, Russia is pumping more oil than at any time since the fall of the USSR — and will keep it up at any price above operating costs (which are far higher than Saudi and Iraq, btw) in order to bring in the hard currency it needs to prop up its Potemkin economy.

Cash-strapped Venezuela and Iran are in the same boat.

And it’s no different with most American drillers. As long as a well has already been drilled and fracked, the capital sunk into the ground, it will be allowed to keep flowing, because the company that owns it needs to generate whatever cash it can to keep creditors at bay.


As for financially stronger producers, many of them still have price hedges in place, whereby their financial counterparties are paying them $20 or $30 more than spot for their oil — giving them the incentive to just keep drilling.

According to the U.S. government’s Energy Information Administration, even as drilling budgets are slashed, U.S. oil production should continue to grow this year, surpassing 10 million bpd.

But eventually, the gig will be up. Rigs are already being mothballed, hedges will roll off, supplies will tighten, WTI discounts to Brent will shrink, bankruptcies and defaults and consolidations will occur, and the price of oil will go back up again. Said Naimi, “The bet is about the timing of the price rise, not about if it will occur.”

So back to that advice for betting on oil. If you like individual holdings, now would be the time to start assembling a basket (I would go with APC, EOG, CLR, PXD and CVX) and dollar-cost averaging into a position with eyes wide open to the likelihood that prices still have a ways to fall. An easier way to do it: dollar-cost average into a good mutual fund. I like Vanguard Energy Fund (VGENX) with its no load and 38 basis points in annual fees. Good luck.


http://www.forbes.com/sites/christopherhelman/2015/01/06/investors-freak-as-saudi-inaction-could-sink-oil-to-20-a-barrel-time-to

Are we to prepare for another global economic meltdown as we saw in 2007/2008?

But why are we queuing for pms in Nigeria? Why is pms still 97naira in our petrol stations. Who would save us?? Is it buhari

This woman enter OPEC badluck.

Government spending is the only victim I see here. Most Nigerians will be fine.

I remember when I used to short sell, this would have been the best period to short sell when the price of oil started dropping, guaranteed gains!

I had to quit trading stocks though, cause men, Miss Cleo isn't always right.

UchihaMadara:
I remember when I used to short sell, this would have been the best period to short sell when the price of oil started dropping, guaranteed gains!

I had to quit trading stocks though, cause men, Miss Cleo isn't always right.

People have lost their shirts off their backs shorting crude oil, in the past six months. If I were you, I will stay far away from hedging anything involving oil, at least till April.

atlwireles:
People have lost their shirts off their backs shorting crude oil, in the past six months. If I were you, I far away from hedging anything involving oil, at least till April.

'

How exactly? The article points out the continual drop in the share prices of different oil producing companies.

So shorting would have been awesome!

I don't expect oil prices to drop to the 2009 figure of $35 dollars before coming back up for the simple fact that US shale oil (which is largely responsible) won't be profitable at that price. American oil companies are cutting back on new investments even as we speak and that means job losses, tax revenue loss etc which will hurt the US economy eventually.

The sensible thing is for all concerned parties to work towards an acceptable price for oil (though I believe the era of $100 oil is over for good). This is what OPEC and Saudi are saying in so much words and inaction.

However for Nigeria, we have to face the truth that our greedy and lazy dependence on oil is over except we want to be left with a failed state. We must start refining internally to sell to citizens and conserve foreign exchange. Every oil company that wishes to continue producing oil in tbe country must have it in their MOU to build a refinery to sell refined products at market price for profit.

There's no other time to go back to the farm. The cocoa heaps in the west must return, the groundnut pyramids in the north must come back while the palm oil industry of the south south and south east too must be encouraged to thrive. There are a lot of things we could do agriculturally. We have the land to do it and we must do it.

Enough of running to abuja to share freebies. Oil will no longer be black gold. Its lustre is fast being eroded.

This is my own layman's contribution to this issue

UchihaMadara:
'

How exactly? The article points out the continual drop in the share prices of different oil producing companies.

So shorting would have been awesome!

Because the results have been too mixed, lacking in direction, and most known big names in the business are doing pretty good. Unless you are trying to play the commodity market directly?

atlwireles:
Because the results have been too mixed, lacking in direction, and most known big names in the business are doing pretty good. Unless you are trying to play the commodity market directly?

K, I gotcha!

Haven't followed stock prices since I stopped trading and was going by the article, though it's kind of hard to imagine an oil producing company gaining overall over this whole period, but then again that's one of the reasons I stopped trading, cause sometimes you can be way, way off.