OPEC's 'Reckoning' Implies Bloodbath Ahead

by: Robert Boslego

Summary

Oil market conditions have defied expectations of producers, traders and experts.

OPEC admits to being blindsided by what happened.

The end game is becoming clearer.

What it means is the 70% drop in prices has not been enough.

A bloodbath looks like the ultimate reckoning.

Like an oasis in the desert of Saudi Arabia, oil's day of reckoning remains a mirage. Market prognosticators think they see it coming in 2016, but many expected it in 2015. Just ask T. Boone Pickens, Harold Hamm, Dan Yergin or Andy Hall.

In July, T. Boone Pickens called for $70 per barrel by the end of 2015. In October, he again called for $70. "I see $70 by the end of the year, but if I miss, I won't miss by any more than six months."

In September 2015, Continental Resources CEO Harold Hamm said, "I think we're at the bottom of this pricing situation." But almost a year earlier, Hamm had ditched his hedges for 2015, expecting oil prices to rebound from $80 per barrel.

Daniel Yergin, famed oil historian, is Vice-Chairman of the firm IHS, which is hosting the conference CERAweek in Houston. Last year his firm stated on its website, "IHS Energy is projecting the price per barrel of Dated Brent Crude will have bottomed out in mid-2015 before starting a modest climb back to the low-$70s by the end of 2016." Mr. Yergin reiterated that forecast in early December.

Now he's saying, "If we have decent global growth, then it does seem to you'll see the rebalancing of the market will happen in the second half of 2016 or 2017 and under those circumstances you could see prices in the $40 to $50 range later in the year."

Andrew J. Hall, the "god of crude oil trading," has been long crude and has been relentlessly adamant that his bet will pay off, even as his fund has lost $3 billion over the past few years.

OPEC "Dazed and Confused"

OPEC Secretary-General Abdalla Salem El-Badri admitted on Monday that OPEC was not "expecting" the dramatic 40% plunge in oil prices that materialized in just the weeks following that landmark decision in November 2014.

But El-Badri said in a rare admission that the policy hasn't worked out as planned, Mr El-Badri said that Opec didn't expect oil prices to drop this much when it decided to keep pumping near flat-out. The group is struggling to co-exist with U.S. shale. "Shale oil in the United States, I don't know how we are going to live together," El-Badri said. Shale drillers can boost output in response to price increases much faster than anything OPEC has ever seen, he said.

El-Badri mentioned that OPEC is open to talks with the U.S. But added, "We are willing to talk to them…we are not looking to cut production or anything but let's have a dialogue. Let us talk to each other." His statement seems to reflect someone who is dumbfounded.

End Game

Saudi Arabian oil minister al-Naimi said that the proposed freeze would not include any production cuts. He admitted that he doesn't know when the current rout will end, which El-Badri described as "nasty."

High-cost producers will have to "lower costs, borrow or liquidate" to cope with the slump in oil prices, according to the Saudi minister. This is a "more efficient" way for the market to rebalance than cuts by low-cost producers, which would only delay the "inevitable reckoning" needed for supply and demand to realign, he said.

The Saudi position has only one outcome: prices will suffer causing enough supply destruction, as time passes for consumption to catch up. The dynamics are now are unlike any other time.

The major producers in the U.S. are large corporations with deep pockets. They aren't going out of business anytime soon. They understand that oil is a cyclical business and can and will accept losses.

The shale oil producers can reduce costs and go on as "Zombies" or sell their acreage to survive. Ultimately, the oil in the rocks will remain there, if under different ownership.

The national oil companies will go on, even if their host countries have to devalue their currencies to pay their workers. They do not have an alternative.

Conclusion

The bottom line: oil prices continue to suffer. Perhaps it takes a bloodbath as a final capitulation phase. Alternatives to this scenario are becoming harder to imagine as solutions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.