Saturday, October 1, 2016

OPEC and Oil prices

Then there was the OPEC announcement of freezing and maybe even cutting back production starting November. Then there were all those skeptical pundits quoted by our ‘reader-scaring news media’, stating that they don’t believe that the agreement is real and that OPEC members will cheat probably from the first moment the agreement is implemented – or possibly even before that.  They are all missing the point. 
The real point is that OPEC members including Saudi are hurting. They have blinked in their price war, which as was said here some time ago, at best would result in a pyrrhic victory. In other words, cutting your nose of to spite your enemy. The real issue is that Saudi has admitted that they cannot keep this price war going forever.  So, if this price war started because there was a miniscule (2 million barrels or 2% oversupply) then wouldn’t pricing go through the roof with a 2 or 3% of supply short fall? Not necessarily so – after all there are probably many derivative owners for each barrel produced; just like with other commodities such as gold.  So, prices will only change when the market psychology changes. That may not happen right away. The combatants have shown their vulnerability – no wonder with OPEC countries like Venezuela being on the edge of social collapse. Even the Saudis are feeling the threat.
Yes, Aramco may produce oil for as little of $2 or $10 dollars – but the profits are spoken for. The profits are committed to Saudi Arabia’s social programs and their military commitments. Probably, the oil price needed for the Saudi Royal Family to stay in power is closer to $50 to $70.  Sprott’s Rick Rule claims the average all-in cost to produce a barrel of oil is $60 while it is sold for $40 to $50 dollars.  So how long do you think this can go on?  Say Saudi Arabia pays the consumer $20 per produced barrel. That means, 10 million barrels x 20 is a loss of $200 million per DAY!

OPEC and possibly even Canada has the power to unleash a price war but halting it may be more difficult. In the end that doesn’t matter. What matters us that OPEC has blinked; that the North American oil revolution has affected the entire world and that we one step closer to an oil price recovery. For me, the most important events of this oil turn-around are: Oil bottomed at 26% which equaled the inflation corrected bottom of $10 per barrel in 1986; Oil recovered to just over $50 and currently is consolidating its doubled price; and Now ‘OPEC Blinked’.  The rest is noise and, as stated earlier, we may be closer to a supply short-fall than many believe.

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