Nothing is ever straightforward in the financial markets. Prices move one way, creating winners and losers. Prices move the other way, and they create another set of winners and losers.
You’ve seen that with the oil price over the past two years. From mid-2014 to January this year, the oil price fell 75%.
There are many theories about why the oil price fell so far — and so quickly. Some say that it was just a matter of supply and demand. Others believe there was a coordinated takedown of the oil price by Middle Eastern interests.
Your editor subscribes to the latter theory. Of course, don’t expect us to produce any evidence to support the theory.
Our rationale was that Saudi Arabia wanted to regain control and influence over both the oil supply and the oil price.
Over the past two years, it appears to have done so. For several years, OPEC had become irrelevant. Nobody cared about its oil production policies.
But now, the market is paying attention to Saudi Arabia and OPEC again. The markets have today paid special attention to the latest news involving OPEC.
As the Financial Times reports:
‘Oil rose to its highest level in a year after Russian president Vladimir Putin said that he backed efforts for a production cap in the clearest sign yet that the country would join any global supply pact.
‘Speaking at an energy conference in Istanbul, Mr Putin said he hoped that the Opec producers’ group would agree on output curbs for member nations at its next ministerial meeting in November.’
The news boosted the oil price. How things have changed.
When it forced down the oil price, it caused panic within the US shale oil industry. This was, an arguably still is, the biggest potential threat to Saudi oil dominance.
US shale oil producers typically have much higher costs. That’s because they’re extracting oil from harder to reach areas, and therefore using more expensive extraction techniques.
This explains why, when the oil price began to plummet in 2014, the number of US active onshore oil rigs began to plummet, too. You can see this from the Bakers Hughes Rig Count index below:
Click to open new window
The number of rigs fell from nearly 2,000 in November 2014, to just 404 in May this year.
But, since then, you can see the rig count has steadily climbed as the oil price has rebounded. Today, the rig count stands at 524, the highest count since February.
This reflects the rising oil price. The oil price has almost doubled from US$27.10 in January, to US$53.06 today.
And just as Saudi Arabia and OPEC’s decision to increase oil production caused the oil price to slump, the apparent decision to cap production has helped boost the oil price. It’s up over 12% in the past month.
Naturally, this is good news for the US shale oil industry. The higher the price, the closer many marginal shale oil producers will get to moving into profit.
For those shale oil producers with lower production costs, the current price may already provide them with good profits.
Of course, you no doubt know that, as the price goes up, the more likely it is to bring supply back into the market. Which makes us think we’ve seen this all before.
OPEC and Russia may be happy to cap production and enjoy a US$50-plus oil price. But as influential as both these oil producing nations are, they can’t control the entire world supply.
If US producers ramp up production, we could soon end up back where we were in 2014, with Saudi Arabia frustrated at losing its influence.
What then? Another crash for oil prices? Let’s not think about that just yet. After all, we don’t want to be a complete party pooper. Let the oil bulls have their fun while they can.
Publisher, Money Morning
From the Port Phillip Publishing Library
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