OPEC Thanksgiving 2.0

This coming Friday, the monthly jobs report will be watched closely regarding its potential effect on the Fed’s decision to raise rates. One other potentially newsworthy event coming up Friday is the semi-annual meeting of the producer members of the Organization of Oil Exporting Countries (OPEC). Their meeting on 28 Nov last year was, as you may recall, noticeable indeed.

The reason was that, last Thanksgiving Day, over in Vienna, Austria, the 12 members met to decide if the group would take steps to support the global price of crude oil. (That price is represented by the prevailing price of Brent North Sea crude.) In times gone by, the Saudis had always stepped up to the pump and either upped – or cut – their own production enough to cause the markets to stabilize where the Saudis wanted. However, at the conclusion of the 2014 meeting, the Saudis refused to cut OPEC oil production despite growing inventories and much lower world oil prices. The Saudi oil minister was quoted as saying he believed that “the oil market will stabilize itself eventually.”

The initial idea behind their decision was to bankrupt our shale industry with lower oil prices. In theory, this would solve the oil glut; push the oil prices up, while allowing the Kingdom, and the rest of OPEC, to preserve its market portion.

In terms of the prices, in June, 2014, the oil price was just over $115 per barrel. At the time of the meeting, it had dropped to just under $80. Last Friday, the Brent price was last quoted at just under $45. This prolonged drop has proven to be particularly tough for the three-quarters of OPEC members who have budgets based on much higher prices.

So, OPEC, how’s that working out for you?

Short version – the OPEC strategy is clearly failing and everyone – except perhaps the OPECs – knows it.

Between 2007 and 2015, OPEC’s global share of the energy market actually dropped from 37% to just 31%. Meanwhile, global demand for oil grew by 6.6 million barrels per day over the same time period.

Further, Canada has become the US’s top oil importer, replacing the Saudis. Meanwhile, thanks to our shale oil and gas production, we’re now the world’s primary source for petroleum and natural gas hydrocarbons, passing both Russian and Saudi production in 2014.

In other words, things haven’t worked out as the OPECs planned and the bill that they might have to pay could be higher than initially expected. Indonesia is re-joining OPEC at this meeting, another fact that may further suggest that their price defense strategy may not be going according to plan.

Unlike the US and the other developed countries, where the benefits of cheap energy have largely offset the negative impacts of the low prices on our oil industry, the OPEC countries with their high dependency on oil exports have been hit hard. Although the US production has slowly decreased, our shale sector has shown a remarkable resilience so far.

The Financial Times reported that US imports from OPEC members is at the lowest level in just about 30 years. OPEC’s biggest collective customer is gone…almost all thanks to the geniuses who have developed those US shale fields.

According to a Goldman Sachs’ forecast, oil prices could fall to as low as $20 per barrel in the next 12 months, as the Chinese economy continues to slow down and storages worldwide quickly run out of space. Personally, I don’t share that view…I think we stay in the range we’ve been in these past few months, between $40 and $60 per barrel.

Edward Morse, global head of commodities research at Citigroup, added that, “Each well currently being drilled in the main US shale plays produces more than 550 barrels a day,” noting that it was 150 barrels on average just a few years ago. He said that, “Only five or six years ago, shale wells used to take 70, 80, 90 days to compete. Today, they take two weeks and those wells run for three months before the decline starts. Costs are much lower, at $35 to $45 per barrel, in the Bakken of North Dakota and Eagle Ford in Texas.”

And now, with the new ‘super-fracking” technology coming on, efficiencies will improve even more, helping to extend the production lives of the fields. We’re just getting started…

Good for shale – bad for OPEC

I think the OPEC producers, with their individual economies almost completely dependent upon oil export revenues, are likely to see much more internal pressure. I think the US production is likely to remain high as our shale industry and technology continue to adapt in order to sustain current production levels, and the banks seem to remain willing to finance it.

Until the global economy regains its overall growth in energy demand, the OPECs are going to face having to cut their own production while sustaining what are ever-increasing domestic demands for subsidies.

Either way, low oil prices are likely to stay for some time.

Investing thoughts

Our current low heating bills and inexpensive gasoline prices should benefit holiday spending.

Depending on which fuel they use, consumers are expected to save anywhere from 4% to 27% on their home heating bills this winter versus a year ago, according to the U.S. Energy Information Administration. Lower prices and balmier temperatures could add up to average savings of $460 a household this winter, in addition to another $50 or so a month for household gasoline savings compared with a year ago.

I’m a firm believer in the cyclicality of markets. I say that because, while the energy sector is currently “underperforming”, this may not be the case forever. Normal demographic growth and increased usage in and by developing markets could potentially help to turn the cycle back higher. Furthermore, while there’s no guarantees, market history has shown that share prices tend to move in anticipation of trends…good and bad.

Energy is typically segregated into three areas: upstream, mid-stream and downstream. Upstream is generally the drilling and exploration phase. Midstream handles the transportation and storage of the products, while downstream is the distribution end.

The major integrated companies, which combine all three phases, together with their nice dividends, appear to present some value here. I also believe that there continue to be many opportunities in the midstream sector. Finally, given the uncertainty as to the timing of the recovery, I think the upstream sector will be the last to recover.

If you look out over three to five years, instead of just the next few months, energy companies may likely, in my opinion, provide you with a very nice potential reward.

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly. <a href=”http://www.russell.com/helping-advisors/EconomyMarkets/EconomicIndicatorsDashboard/EconomicIndicatorsDashboard.aspx”>http://www.russell.com/helping-advisors/EconomyMarkets/EconomicIndicatorsDashboard/EconomicIndicatorsDashboard.aspx</a>

Past performance is not indicative of future returns.

Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.

Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.