Energy Independence: Did The Saudis Hang The U.S. Out To Dry?

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Includes: BHGE, BNO, CRUD, DBO, DNO, DTO, DWTI, HAL, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI, XLE
by: Andrew Hecht

Summary

OPEC says let it fall.

The winners and the losers.

A repeat of 1986?

A hope for the US oil patch.

Markets are efficient.

The OPEC met in Vienna on Thanksgiving Day, and they decided to let the price of crude oil fall - and fall it did. Prior to the meeting, the price of NYMEX crude oil stood at $73.69 per barrel, some 31.6% below the price on June 25, just five months earlier.

With the news from OPEC, crude oil fell another 10.23% by Friday, closing at $66.15 per barrel on the active month January futures contract - the lowest price since May 2010. The price of Brent North Sea crude oil dropped in lock-step with NYMEX crude, closing Friday at $70.17 per barrel. Oil products also took it on the chin, with January NYMEX gasoline closing at $1.8202 per gallon, the lowest level since December 2009. January NYMEX heating oil futures closed Friday at $2.1606, the lowest since September 2010, despite cold weather in the US and a seasonal bias for heating oil to rally. The next level of minor support for NYMEX crude is at the May 2010 lows of $64.24 - below there, who knows.

In past years, the relevance of OPEC has been on the decline. Higher oil prices have blessed the members of the cartel with huge profit margins. Let us remember that prior to 2004, NYMEX crude oil never traded above $41.15 per barrel. At the same time, the high price for crude has increased global supplies, as higher production cost crude, particularly from shale oil in the United States, has eaten away at the cartel's market share. Saudi Arabia is the number one exporter of crude oil in the world. As such, the country is the strongest and most influential member of OPEC. So long as the price of crude oil remained at lofty levels, there were no complaints, but the meeting on the Thanksgiving holiday in the US came at quite an auspicious time. With oil prices dropping like a stone, the world set its sights on and held its breath for any action the cartel might take. Some opined that there might be production cuts to support the weak economies of some struggling members like Venezuela, Nigeria and Algeria. Others argued that production would hold steady in order to destroy the economics of US production, thus rendering OPEC market share more important in the future. Many political considerations affect the price of oil. Crude is perhaps the most important geopolitical commodity that trades. I myself opined that there might have been a backroom agreement with the Saudis to hold prices at the $80 level; alas, I was wrong. I felt that as coalition partners in the war against ISIS in Syria and Iraq, Saudi Arabia and the US might have cooperated to manage the price of oil. I was wrong - if this was in fact the hope of the US administration, then the Saudis hung the US out to dry.

The winners and the losers

Clearly, as crude oil drops, producers are losers and consumers are winners. Therefore, the biggest winner is China - the country that is on the demand side of the equation in most commodities has been suffering from sluggish growth in 2014. Lower crude oil prices are a welcome stimulus for the world's largest-growing economy. US consumers are also big winners. They will pay less at the gas pump, less to heat their homes, and lower crude prices will lessen the chances of inflation in the near term. Politically, it is a mixed bag for the US. The lower oil prices go, the worse off the US energy sector will have things. High-cost production will now have to take a long hard look at whether it is economical to produce. This means that US energy independence and some US and Canadian jobs could be in jeopardy. In a world of tension and problems, particularly in the Middle East, this could be a dangerous long-term result for America and Canada. Ordinarily, Europe would be a winner given lower crude prices; however, their economy is such a basket case that lower energy prices are a little "too little, too late." Japan is a winner, as is India and other importing nations around the world.

The losers are clearly producing countries, led by the biggest non-OPEC producer, Russia. Tensions between Russia and the world community have resulted in sanctions; a diving oil price adds insult to injury for the Russia leader. While he has arranged to supply oil to China, the Chinese will be paying Russia market prices. Russian leader Mr. Putin is currently working on energy deals to supply India with crude oil. Given sanctions, the Russian leader is scurrying around to make sure he can find a home for Russian crude. Current oil prices guarantee a very tough road and deep recession for the Russian economy. Leonid Fedum, vice president and board member at OAO Lukoil (LKOD), put a positive spin on lower prices. "In 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again... The shale boom is on par with the dot.com boom. The strong players will remain, the weak ones will vanish." As expected, and given current tensions between the two nations, the Russian went on to say, "The major strike is against the American market."

With Saudi Arabia in a dominant position, I still doubt this is a targeted action by OPEC. While the Russians are saying that the US will suffer, it's actually the Russians who suffer most from lower oil prices, given their status as pariahs. More importantly, Saudi Arabia is afraid of something that transcends the price of oil. ISIS has the oil-rich kingdom in their crosshairs, given the significance of the country to Islam. Saudi Arabia depends more on the United States for survival than any other nation on earth.

Iran, who reportedly supported the OPEC non-action, is also a loser. Lower crude prices put more pressure on the country to do a deal and sign a treaty with the US and European nations, given economic weakness after years of debilitating sanctions. Greenland is a loser; higher oil prices gave the tiny nation hope that they might achieve independence from Denmark. Other losers include oil-producing and exploration companies around the world. The Energy Select Sector SPDR ETF (NYSEARCA:XLE) fell below $80 on Friday to close at $79.82 per share. It is possible that we will see a wave of consolidation in the industry in coming months, given new pressures on the sector that was booming only a few short months ago. The recent merger between Halliburton (NYSE:HAL) and Baker Hughes (BHI) may just be the first of many such marriages of convenience.

A repeat of 1986?

In January 1986, the price of crude oil hit rock-bottom at $9.75 per barrel. The Saudis opened the spigot and ignited a four-month plunge in oil prices, which had a devastating effect on the US oil industry, causing a twenty-five year span of declining US production. Some analysts are hearkening back to the days of that trade war, pointing fingers at the Saudis for the lack of action at the recent OPEC meeting. Given the reasons mentioned above, it is highly doubtful, if not insane, to think that the Saudis would dare to incite a trade war at this time - particularly with a country that is their last line of defense against radicals watering at the mouth to take over their home and wipe the ruling royal family off the face of the earth.

A hope for the US oil patch

Necessity is the mother of invention. The US, after many years of dependence on Middle Eastern oil, has finally found independence. It now behooves the American oil industry to come up with technology to lower production cost. Another answer may lie in natural gas and fracking, where the US has enormous reserves, particularly in the Marcellus and Utica shales. While environmentalists oppose increased fracking, US strategic national interest depends on a policy of energy independence.

Markets are efficient

Lower oil prices will lead to lower production costs across many commodity markets. Lower production cost will lower price levels for many commodities, as producers will be able to remain economical at lower price levels due to the drop in energy prices. The markets are efficient, and the price of crude oil is proving that right now. Increasing global supplies and a slowing global economy has led the price of this commodity lower. The drop in oil is most likely signaling the next leg down in a sector-wide bear market in commodity prices.

There are winners and losers each time the price of a staple corrects higher or lower. In this case, crude oil is traditionally the most important political commodity in the world. Therefore, the effects of the current slide in oil prices will reverberate through the global economy and political landscape for years to come. Remember that markets are cyclical. Given the finite nature of natural resources, it is only a matter of time until they reach the bottom and reassert themselves, creating the next cyclical bull market. In the meantime, we will have to wait until June to hear from the OPEC cartel again, unless of course, the oil market gets out of control. Stay tuned...

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.