Fact or Fiction: Saudi Arabia Caused Oil Prices to Collapse

{Alert: Long term stock market investors should have raised more cash this week as stocks crossed under their December lows today at Dow 17,116 & SP 500 Index at 1993. Stock market exposure was reduced from 90% to 85% as discussed in our 12/15/15 report (https://execspec.net/bad-news-2-gas-futures-trading-profits/) Traders have been 100% in cash since August. A test of the 10% correction zone under SP 1900 is now more likely and a retest of the 14% correction low from August will be a short term target “if” $32 oil fails to hold. N.Korea’s Hydrogen Bomb test today was not the primary bombshell destabilizing markets today, but the China syndrome has elevated fears.}

Headlines Imply Saudi Plan to Destabilize Oil Markets

Over a year ago rumors flew that Saudi Arabia was behind the late 2014 oil price implosion. Just last week Russian Energy Minister Novak claimed  “Saudi Arabia has this year (2015) increased production by 1.5 million barrels per day, thus effectively destabilizing the situation on the market,”.( http://www.businessinsider.com/russai-says-saudi-arabia-destabilized-oil-market-2015-12 ). The House of Saud leads the OPEC (Organization of Petroleum Exporting Countries) cartelA year ago Saudi Oil Minister Naimi said OPEC countries deserve to retain a higher market share than others, with a veiled threat towards Russia’s inefficient oil fields. It’s alleged here that Russian officials think the Saudis cratered oil to force Russia to join OPEC. Repeatedly we hear statements of assumed fact that Saudi Arabia is behind some devious plan to crush the higher cost Oil fields in the US, Canada and Russia by increasing production until they can regain controlling market share status of their halcyon days. 

Fact: Saudi Arabia Never Caused Oil to Crash!

The wise Saudi Oil Puppet Masters and OPEC are not Obi-Wan Kenobi and never saw or engineered the 18 month rout in energy prices in 2014-2016. Perhaps it would be more accurate to say they are helping to keep prices low, but they never wanted Oil to collapse. While a 6% supply increase certainly isn’t a flood, we can see by the ensuing chart that Saudi Oil production was “falling” prior to the historic price drop in 2014 and they only began increasing supplies AFTER Oil bottomed at $42/barrel. 

Saudi Oil Production

So why would Saudi Arabia increase production “after” oil prices fell 60%? They had NO CHOICE!  Sure they wanted to regain market share by wiping out US and Canadian fracking production which had been growing at parabolic rates for several years. There is NO doubt that North American energy supplies catalyzed Oil and Natural Gas prices to disintegrate. Energy prices have never crashed in modern history during a consumption growth cycle. Falling prices during rising demand means there is new supplies and new technologies at work.

Saudis Could Either Elevate or Reduce Oil Supplies

False Choice #1: Severely restrict production and lose market share to keep prices elevated and ensure a violent overthrow of existing OPEC Government’s or financial depression:  The Saudi’s false choice was to lead OPEC in a sharp constriction of supplies to maintain profit margins and high prices. Such a foolish decision, that was requested by some in OPEC, would have permanently acquiesced significant and growing market share to the new high tech Western World countries and emerging markets that would guarantee the demise of all OPEC participants – financially and socially.  Elevated prices would lead to rising supplies from non-OPEC entities and result in a rapid and sustained loss of market share inside OPEC and eventually lower Oil prices no matter how much supply they held back. Such a path would commence the countdown to either total economic collapse and or an extreme radical coup d’etat. Middle Eastern and virtually all OPEC members rely extensively upon petrodollars to bribe their radical populations and pay for vital military security. Already the Saudi’s have seen 55% of their exports wiped out due to Oil deflation. Reducing Oil revenues further with lower production would be suicide with the Barbarians at the Gate.

Only Choice #2: Maintain peak production until higher cost non-OPEC  producers lose enough money to idle rigs,  exploration and to curtail their supplies. Lower non-OPEC production would shift market share back to the Saudi led OPEC and allow a longer term return to higher prices and profits. Thus the market share usurpation by the Saudi’s was not by choice, but by default. They can either invite their own rapid demise by curtailing supply and long term market share “or” they can hang on for the medium term with a modest increase in market share and risk a new era of sub $60 to $80/barrel Oil. Should prices rise back to $80 to 100+ then new supplies would again flood the market from even more countries than before as horizontal fracking technology expands and break even costs are reduced.

Saudi exports

There was never a brilliant chess move by the Saudis to drive Oil prices lower, it was simply the hand they were dealt. With Saudi and Kuwaiti break even production costs close to $10 a barrel of crude oil they modestly elevated supplies close to their ceiling to maximize revenue and gain market share in the dire deflationary environment. Our chart below is a couple days old and already out of date as we type with Brent Crude Oil falling below $34 a barrel today – yet another new low. It was not the Saudis original plan, but increasing market share while shutting down higher cost producers in the North Sea, Russia and the US and elsewhere is the only realistic option OPEC had once the Oil glut reached the boiling point in July 2014. While producing at $10 and selling at $35 sounds immensely profitable, it’s a tremendous risk for a society of  Saudi Sunni Muslims dominated by Wahhabism – the most radical interpretation of Islam. Maintaining the Saudi military and welfare budget is critical. They can tap their $700 Billion war chest, but even this will be depleted within 5 years at the current pace. Meanwhile social unrest is rising and Middle Eastern tensions continue to proliferate.

OPEC break even

Normally commodity supplies decline in tandem with prices, but most of the worlds Oil comes from dictatorships who would rather fight for market share with higher production.  Global output has risen almost 3 million barrels per day since Oil prices fell from $108 to $35. We discussed this potential several times since the 2014 peak as we highlighted the example of Natural Gas  which collapsed in 2008, yet production continued to rise even 7 years later.

OPEC production rises

Permanent Plateau of Cheap Energy

 Less than 2% of Global Oil sources are considered to be unprofitable at $40/barrel Oil. Even in the $20’s most Oil will continue flowing near current levels as the marginal costs and hedges sustain enough cash flow to resist the added cost of actually shutting down wells.Once Iran comes fully online by 2017 oil supply may flatten out while consumption continues to grow, but oil would likely need to fall close to $20 a barrel short term or sustain average prices in the $30’s or lower for years to induce an eventual rise in Oil prices back toward $100+ a barrel. Even then such a move would be fleeting before the non-OPEC hydra grew more heads to regain market share. Until some Globally Progressive new order can exact carbon controls we should expect a long term era of cheap energy in the 2015 to early 2016 price range that is currently being carved out.

Oil Outlook

The first wave down in West Texas Intermediate (WTI) from $108/barrel in July 2014 bottomed at $42 last March. After the forecasted seasonal rally into the summer above $63, prices completed their second leg lower to about $40 last August. Our Bearish forecasts since 2014 have continued to project lower targets and we still expect a retest of the 2008 lows near $32.48 and possibly an overshoot drop into the upper $20’s

Oil Jan 2016

Billions and Billions

Last week US crude inventories fell by 5.6 million barrels. This may sound Bullish, but gasoline and distillate fuel inventories rose by 12.6 million barrels. Globally oil stocks have reached 3 Billion barrels and will continue to grow in 2016. It takes Billions of dollars and many years to bring Oil fields online. Some new oil fields are only now “increasing” their production while others will accept losses for extended periods to avoid the cost of shutting down and starting back up in later years. Every quarter for the past 2 years global oil production has exceeded consumption. This has had a palliative effect upon consumers by increasing their purchasing power and it should continue throughout 2016 as supply growth will remain above demand.

Global oil chart Jan 2016

Natural Gas is a Glutton for Gluts

Natural Gas is more than 25% cleaner than diesel or gasoline and 40 to 50% cleaner than various types of coal. Fortunately the US is the Saudi Arabia of Nat Gas with a surplus ripe for export when global prices rise. When Nat Gas prices peaked about 500% higher back in 2008 US production was surging. Since then 80% of the gas drilling rigs have been shut down as prices plunged almost 90% into the 2012 and 2015 lows. Yet production levels continue to grow and inventories are sitting at all time record highs.  This phenomenon has continually surprised analysts since 2008 and as a similar process has unfolded with crude oil since 2014 they have again been fooled. A vast reduction in oil drilling rigs, record low prices beneath the cost of production and rising bankruptcies DO NOT necessarily mean future production will shrink and translate into higher prices. We have made this argument multiple times since the Fall of 2014 that cash flows, cost of termination and the quantity of investment in future production are among factors allowing supplies of Oil and Natural Gas to continue rising. We should also note that the majority of fossil fuels are supplied by dictatorships who can ignore free market profit and loss motivations. Natural Gas (NG) will have its day and enter a new Bull market, but it will take better economic growth and colder La Nina weather to turn the ship. Below we have our estimate of the zone where the seasonal inventory draw down will bottom this spring. Should NG inventories fall below the 2015 low, then prices will put in a low and begin a longer term uptrend soon. If our forecasted zone near the 2 to 2.5 trillion cubic feet  contains the stock draw down through March, then we would expect the continued slide in prices to new record lows into the 2nd or 3rd quarter of 2016. 

Nat Gas Jan 2016

Lower energy prices and higher Yen carry trade values continue to be Bearish factors for the stock market, which may be chomping at the bit for a strong energy price bottom to turn the light green. Recent Purchasing Managers Index readings from Brazil, India, US and especially China have given renewed concerns that the Global economy is continuing to slow which adds to the vicious cycle in energy prices. 

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