OPEC: Cynical Thoughts

I am very skeptical of OPEC’s ability to actually curtail production. OPEC agreed on Wednesday to cut production by 1.2 million barrels per day and bring the ceiling of production to 32.5 million barrels. Oil prices rallied almost 15% on the news, as the market was not prepared for this outcome. Chatter before the meeting had been that cuts were unlikely.  I’m doubtful this price move means anything, other than the fact that punters in the crude oil market got caught offside. 

First, Indonesia “suspended” their membership in OPEC.  Production of crude in Indonesia has been declining for years.  They failed to reinvest in their fields and now are a net crude oil importer.  They had already suspended their membership once, and according to the EIA, “The government's annual crude oil and lease condensate production target, which has not been reached each year since 2009, is 825,000 b/d for 2015, revised down from an original goal of 900,000 b/d.”

Second, lets parse this statement, “Hence, it is under the principles of good faith that countries participating in today’s meeting agree to commit themselves to the following actions:” So under principles of “good faith” there is going to be an agreement amongst . . . wait for it. . . . Russia, Saudi Arabia, Iran, and Iraq and others to cut their production. Further, the good folks in Algeria, Kuwait, and Venezuela are going to monitor compliance of the agreement. Granted, there are no tools to enforce compliance, but you know, you may not get invited to the next indoor ski event in Dubai if you break the rules.

Vail Resorts, Dubai

Vail Resorts, Dubai

Meanwhile, many of these countries are running massive budget deficits. Iran and Saudi Arabia are waging a proxy war in Yemen AGAINST each other.  Iran in fact got to increase production a little, which comes right out of Saudi Arabia’s 486k barrels a day of production cut.  Plus, Russian Oil Minister Alexander Novak say they would cut “gradually”, but they did not say from what level.  Venezuela, one of our “reliable” monitors, is on the verge of civil society breakdown. The debt in its state run oil company, PDVSA, trades at 36 cents on the dollar. People are without food and medicine.  Yet, don’t worry, they are going to kick in 95k barrels a day in adjustments.  That’s a cool $5,000,000 a day in much needed hard currency.  That could buy a lot of rice and beans for starving children.  But don’t worry, they are in. Saudi Arabia just had to tap the bond market for financing for the first time ever to avoid raiding the sovereign wealth funds. 

Plus, what’s up with the blank lines from Libya and Nigeria in the report? This is important. I mean, Nigeria produces 1.9 million barrels a day and Libya produces 250k barrels a day.  Do they just get a free ride?  Nigerian production is down 15% yoy due to domestic issues with terrorist blowing up pipelines and such. If they just got back to their normal rate of 2.3 million barrels, that would negate the Saudi cut. Libya, before all hell broke loose, would produce 1.3 million barrels on a good day. 

Anyway, the short term effect worked. Hopefully, these exporters are out their locking in all their sales for next year at the higher prices, because I can tell you, in the next 6 months, this won’t matter. Why? First, US Shale oil power is rising.  Geologist just found THE LARGEST NEW RESERVE EVER in the US.

The Midland Basin of the Wolfcamp Shale area in the Permian Basin is now estimated to have 20 billion barrels of oil and 1.6 billion barrels of natural gas, according to a new assessment by the USGS.

Plus, Exxon Mobil  found a large find in Nigeria, with 500 million to a 1 billion barrels. Oh, and they found a big one in Guyana as well (right next to Venezuela btw), for another potential 1.4 billion barrels. Exxon Mobil is not in OPEC nor is the United States for our oil novices. 

The move can be seen on the Pre and Post Announcement Crude Oil curve below. Front dated oil moved up significantly. This is where the futures traders and speculators mainly play. However, it seems producers used this as an opportunity to lock in higher prices. The longer dated part of the curve is actually lower post OPEC. Likely they used the volume in the market to their benefit. 

The power of Shale has provided the US what years of Middle East invasions, US supported dictators, and arms sells could not. The US is now essentially energy independent.  Without a society of people to care for with our oil revenues, the US can plow the earnings from oil back into making our drilling technologies more efficient, cleaner, and more cost effective. Plus, with a plethora of private US producers, investment allocations can be made in extremely rational manner, not by some State Oil gorilla like PDVSA, Saudi Aramco, or Petrobras which tend to breed popular mistrust and corruption.   US producers will find a way to squeeze down the marginal production cost of oil.

Anyway, all I’m saying is, I’m cynical on another major boost in oil prices. I don’t necessarily think there will be a big drop again either, I just think its dead money for now. If you can make money at $30 a barrel, then do that investment. If you are counting on $60 or $70, stay away. Demand for oil is weak due to slow global growth and rising fuel efficiency standards (most of the major auto companies plan to release electric vehicles in the next 5 years).  China fed the great oil rally from 2003 to 2012.  Now with their own debt overhang, they won’t likely be the ones to grow global oil demand. Perhaps India could, but they don’t have the infrastructure to support a car for every citizen.  That is years away.

Supply is abundant, and we have some cracked out countries desperate for more US Dollar revenue to support their regimes.  The fact is, OPEC countries, to some degree, support a society of people dependent on oil.  See this chart which shows the fiscal dependence of Oil countries.

Oil Fiscal Breakeven.PNG

 

These countries have failed to provide education and job opportunities. They’ve propped up ruling dynasties by handing out subsidies to vast swaths of the population. Without profits from crude oil, they are toast.  Their promises cannot be trusted and their motives are simple.  Support prices and try to maintain control of your population.  With US Shale now a global force in the oil market, the Cartel's soft power is significantly eroded. The stone age didn’t end with the world running out of stones.  The oil age will not end with it running out of oil.  Buyer beware.