Saudi Arabia: Let Oil Markets Ring

|
Includes: OIL, SPY, USO
by: BubbleBustInvesting

Summary

American Frackers have changed the game in the oil market.

Saudi Arabia is no longer the biggest oil producer.

OPEC in disarray.

Volatility to continue in the oil market.

Speaking in Houston on Tuesday, Saudi's oil minister Ali al Naimi had a clear and loud message for oil traders and investors: there will be no oil production cuts. This means that market forces will determine the price of oil.

Mr. Naimi's message reflect a new reality in the oil market - Saudi Arabia and OPEC, which that country once controlled, is no longer a price maker in the oil market.

There are two reasons for that.

First, Saudi Arabia is no longer the bigger oil producer in the world, America is.

According to Kevin Rooney, CEO, Oil Heat Institute of Long Island:

"From an energy supply/price standpoint, the dramatic expansion of hydraulically fractured oil which led to the re-emergence of the US as a major oil producer over the past few years has indeed exercised some degree of 'control' over the Saudis (and indirectly other OPEC members) by replacing them as the critical 'swing producer' in the global energy supply/demand/price balance. However, the Saudis know how to play the 'long game' and they are very astute in their current approach which, simply stated, is to wait out and weather the precipitous drop in crude prices until higher cost US producers fall by the wayside and they return, once again, to their long held position as the critical 'swing producer'."

World's Five Largest Oil Producers in 2014

Country

Oil Production (bbl/day)

USA

13,973,000

Saudi Arabia

11,624,000

Russia

10,853,000

China

4,572,000

Canada

4,383,000

Click to enlarge

Second, OPEC is in disarray, with Saudi Arabia and Iran turning into hostile brothers, turning oil into a weapon to be used to fight against each other. Besides, Iran must sell oil as fast as it can to regain its pre-sanction market share.

What does this new reality mean for the price of oil? It can go in either direction, towards $20 or towards $40.

At this point, it's very hard to place bets on either side of the oil market for more than a few days or even a few hours.

Still, there are a few things to watch, on the demand and the supply side of the market, to determine whether oil heads north or south.

On the demand side, you should watch weather, especially in the Northeast US, a large market for heating oil. All it takes is a couple of more snowstorms like Jonas, and oil will head up into the $40s very quickly.

Still, the prospect of snowstorms is very unlikely, as more than half of the winter is already gone. That's why weather may end up pushing oil towards the $20s rather than the $30s.

Another factor on the demand side - the most important factor - is global economic growth.

All it takes is another downward revision of world economic growth by international institutions like the IMF, OECD and the World Bank, and oil heads for $20. Conversely, upwards revisions of global growth can push oil towards $40.

Then there's the prospect of US interest rate hikes. Should the Federal Reserve proceed with its pre-announced rate hikes, oil will head for the $20 mark.

On the supply side, there are the American frackers, fighting for survival. Will they continue to plumb oil to pay bills and stay in business, or shut down altogether?

While it is hard to forecast how things will turn out in the end, one thing is clear: volatility will continue in the oil markets, and may spread into equity markets, too.

ETF

30-Day Return

US States Oil (NYSEARCA:USO)

-0.70%

iPath S&P GSCI Crude Oil (NYSEARCA:OIL)

1.77

SPDR S&P 500 (NYSEARCA:SPY)

2.82

Click to enlarge

Source: Finance.yahoo.com

Disclosure: I am/we are long SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.