An economic thesis on oil is the only way that the average investor can get a grip on what's happening internationally with the price of oil. The United States Oil ETF (NYSEARCA:USO) is trading lower than it was in 2009, presenting an opportunity to truly buy low and profit on the rebound.
It was in August of 2014 that speculators reduced long positions by nearly fifty percent on futures contracts of oil, exerting downward pressure on prices. Hedge funds trimmed their net long positions by 45%-73% in Brent Crude. These movements created a domino effect in destabilizing trading patterns in oil that can potentially destabilize financial institutions and pull them apart due to the sizeable investments in oil exploration.
Ali-Al Naimi, the Saudi Arabian Minister of Petroleum and Natural Resources, is a quiet man with few words. He elevated himself from his modest upbringing from supervisor of the Abqaiq Production Department to Oil Minister. It was rumored that he was the only one to tell billionaire Prince Al-Waleed bin Talal to keep quiet about increasing US shale production and that he knows nothing regarding oil and politics. On May 31, 2013, Ali-Al Naimi stated he wasn't concerned about increasing US output from shale formation. Just recently, the Saudi billionaire Prince Al-Waleed changed his tune. He stated, "The world's top oil exporters should start worrying about the recent slide in global oil prices." He warned against such a negative effect of such a drastic drop in oil as it reduces state revenue for Saudi Arabia. Prince Al-Waleed is quite young and unusually outspoken for a top Saudi businessman. He stated that 90% of the 2014 budget is based on oil and that to underestimate these implications is a disaster, which cannot pass unnoticed. In March of 2012, Ali-Al Naimi indicated that the world oil supplies were in excess of demand and crude at $125 a barrel was not justified given the anemic state of the world economy. "My only mission is to convey to you that there is no supply shortage in the market. We are ready and willing to put more oil on the market, but you need a buyer. We really don't understand why oil prices are behaving like this. Supply of oil is now outpacing demand by over a million barrels a day and customers are not asking for extra crude." He added that he expects the next month's production of oil to stay at 9.9 million barrels a day. We ask the customer, do you need more oil? Invariably the answer is no thank you. At that time, the US dollar versus the Canadian dollar averaged $1.02. The American dollar was strong, even with a surplus of oil. So what has changed?
Saudi's Oil Minister Ali-Al Naimi is a very simple man. On December 11, 2014, he stated, "The markets will balance themselves out. We produced 9.6 million barrels per day of crude in November, which is consistent with October." He added, "You come from a capitalist nation where the markets are always going up and down." On December 12, 2014, the US Energy Information Administration ((NYSEMKT:EIA)) gave a short-term outlook on oil. WTI future contracts for March 2015 delivery traded on average $67/barrel, establishing the lower and upper limits of 95% confidence with market expectation averaging $51 to $89 per barrel. The EIA also stated that the environment of oil has become unpredictable in this forecasting environment. Furthermore, EIA also indicated that OPEC and non-OPEC producers rely heavily on fiscal budgets and now they must choose to assert austerity programs to meet those budgets. Investors need to make an informed decision by piecing together the clues of this jigsaw puzzle.
Rafael Ramirez, the recent Venezuelan Minister of Energy, and Igor Sechin, Executive Chairman of Rosneft, traveled to Vienna seeking to cut oil production. The outcome was rather interesting. Rafael Ramirez stormed out because Ali-Al Naimi indicated that he would not cut oil production. Igor Sechin took a rather different approach, he quickly sent out a press release saying that Rosneft will not cut oil production saving face. The comedy gets better, Rosneft has asked for $49 billion from the National Russian Welfare Fund, which is about 60% of the fund. Novatak asked for $3.9 billion from the Welfare Fund. Even though Russia has $420 billion in reserves to mitigate the Ruble decline, it may not be enough if oil declines further. The US expressed caution by stating that the possibility of adding further sanctions against Russia for their intrusion into Ukraine is very real. Following this statement from the US, Ukrainian President Poroshenko indicated that a 'real' ceasefire was in place in Ukraine after the nation experienced its first day without military casualties in over seven months. This gives Vladimir Putin a way out in terms of not looking weak and conciliatory to US demands. Oil speculators seem to have given the media some false truth. Increased inflation in Russia has led to a decline in the business and service sectors. Russia's central bank interest rates hiked to 9.5% in November, which does little to support currency and control inflation.
Headlines: 'Naimi Declares Price War on US Shale Oil'. Frankly, the real war playing out is with Canadian oil producers with close proximities to US markets. Canada ships more oil to the US than Saudi Arabia. As much as 24% goes to the US, as opposed to Saudi Arabia exporting only 13% to the US. That percentage will increase if Saudi Arabia increases military expenditures with the US. It is Canada that declared war on US shale producers. The US oil surge is forcing Canadian producers to look elsewhere for their oil. Canada is rapidly building infrastructure to ship their oil to high-price Asian markets. Another problem with Canadian market share in the US is that it does fluctuate and could decline to 19% due to Saudi oil.
In June 2014, China was hoarding crude at the fastest pace ever, keeping prices at $100 per barrel. Chinese President Xi Jinping is building stockpiles in spite of Russian sanctions. At $60 a barrel, Jinping is ramping up oil inventory even faster than April and June. For China, this is simply a panicked stockpiling of resources at lower prices. China knows that oil needs to be harvested, consumed, and stockpiled, regardless of whether or not there is a global surplus of 1 million barrels a day. Remember, China will not announce when it fills its oil emergency reserves. There is no public data available for analysts to measure.
Chevron (NYSE:CVX) has several big mega projects, including the Rosebank Oil and Gas Field partnered with Statoil ASA (NYSE:STO), to maximize revenue and increase production. Chevron's Wheatstone project is almost complete. However, with lower oil prices, Chevron may have to sell assets even though the company has a large cash balance. Furthermore, ConocoPhillips (NYSE:COP) announced that they're cutting capital budgets by 20%.
Oil is the one commodity that commands a $15 trillion investment from banks and governments globally. The oil and natural gas industry supports 9.2 million American jobs and provides $1.1 trillion in US economic activity. It is 7.7% of the total American GDP. The oil and gas industry is the largest employer and purchaser of goods. So why did the US and Saudi Arabia collaborate to bring down oil prices? American relations with Saudi Arabia are very strong. Saudi Arabia's military expenditures have more to do with the balance of power in the Middle East. The concerns of Saudi Arabia stem from Iran's commitment to develop nuclear weapons and its refusal to suspend uranium enrichment programs. Saudi Arabia has been an opponent of nuclear weapons in the Middle East having signed a non-proliferation treaty coalition of Middle Eastern countries as a nuclear-free zone. Iran views their nuclear initiative as a national achievement. Iran is a member of OPEC and Saudi Arabia is unable to punish them.
The Dubai Financial Market is highly leveraged with real estate. Many of its major ongoing construction projects including Dubailand and the Arabian Canal have been postponed in the wake of tumbling oil prices. The relationship between oil, real estate, and financial markets has been thrown out of equilibrium. The financial market in Dubai is at a 6-year low and continues to decline. The United Arab Emirates has major investments in the US, if they choose to liquidate their assets, the American market will suffer catastrophically.
Remember one thing with Iran, it certainly has a long history of covert nuclear activities that may even surprise the United Nations. For U.S. negotiators to think that they will get a miracle 'deal' with Iran is just paving a road where the balance of power would change rapidly. Investors need to be mindful of certain events. On December 17 of 2014, Iran is expected to resume negotiations with world powers to ensure that Iran will never develop nuclear weapons under the guise of civilian activities. Iran wants oil sanctions lifted, which are currently strangling their economy. In return, they expect to receive $700 million in frozen assets per month. If Iran complies with the United Nations then within a year sanctions should be lifted. By rolling the dice on oil, the US has shown weakness in diplomacy. Israel's Defense Minister, Moshe Ya'alon, had to apologize to the United States for stating that they are weak in the diplomacy department with Iran. Al Jazeera America, an American based cable and satellite news television channel, indicated "Stakes remain high in Iran nuclear talks, even though a consensus wasn't reached in November." This would guarantee that Iran never develops nuclear weapons and offers Tehran a clear path back into the community of nations.
I believe Iran's $100 billion nuclear infrastructure will not be dismantled by low oil prices or by stronger bargaining positions from the US and Saudi Arabia. Iran cannot have the bomb especially if Saudi Arabia doesn't have one. The weakening of American and international investments in the harvesting and production of oil could be the Achilles heel that could send the world economies into steep economic decline. Chevron, Exxon Mobil (NYSE:XOM), and Royal Dutch Shell (NYSE:RDS.A) spent $120 billion to boost oil and gas output. The bets are massive. The oil industry believes that constant expenditure is necessary in order to not fall behind. Iran and Saudi Arabia's theocracies are playing out in the oil fields. The oil companies did hedge, but it wasn't enough to compensate oil at $50 a barrel, and that caught many by surprise. $80 a barrel was an acceptable price temporarily for many shale producers.
Five days ago, Abdullah of Saudi Arabia, King of Saudi Arabia, cleaned house with the most sweeping cabinet shakeup in years. It is rumored that many of his cabinet ministers were outraged that they had to sacrifice their own economic stability as a bargaining ship for Iranian negotiations. Just last year, the BBC reported that Saudi Arabia invested heavily in the Pakistani nuclear weapons program and could easily acquire nuclear weaponry if Iran crosses that threshold of obtaining the bomb. The no-proliferation treaty in the Middle East is pushing Israel and Saudi Arabia to the brink of irritability. Ya'alon, Israel's Defense Minister, said that Israel must prepare for the possibility of striking the Iranian nuclear program on its own. Saudi Arabia's cabinet ministers endorse that stance and now feel that the collaboration with the US to bring down oil prices was a miscalculation. Defense Minister Ya'alon further added that he will do what needs to be done when it needs to be done.
North Korea is a strategic partner with Iran by assisting their scientists with their nuclear initiative program. Congressman Tom Cotton told reporters on December 8, 2014, that "Iran is getting everything it wants in slow motion, so why would they reach a final agreement?" Mike Pompeo, the US Representative for Kansas, urged the United States and its allies to "strongly consider a pre-empted bombing campaign of Iranian nuclear sites." The Institute for Science and International Security is continuing to put up press releases that time is running out. December 12, 2014: "The US Should Stop Iran From Buying Material for the Arak Plant." December 8, 2014: "US Accuses of Iran of Secretly Breaching U.N. Nuclear Sanctions." December 8, 2014: "Speculation Concerning Israel's Pre-Emptive Strike on Iranian Nuclear Facilities Emerges."
The US fracking boom was built with debt, with most of it coming from junk bonds. Debt tied to oil may be the new subprime prices. Oil shale companies purchased land convincing Wall Street that it should be worth five times more than what it's currently priced at because of oil embedded in the rocks. They want to unload the land as quickly as possible to other shale companies at a profit before interest rates eat up their cash flow. These types of junk bonds only stay afloat as they continue to pay the 6% to 9% to investors as long as oil prices remain high. These bonds are worthless and Wall Street is well aware of that. The Fed is not in a business of buying oil assets, but we may need to convince them. So my question to investors who want to make money is what is the best course of action? When oil hits $51 a barrel, then load up the boat with oil-based company stocks such as Chevron, Exxon Mobil, Suncor (NYSE:SU), Halliburton (NYSE:HAL), etc. Yes, the boat could sink. However, I'm hedging that after December 17. The US will use its strategic petroleum reserves to simply get rid of the surplus. Or, it will leave Saudi Arabia and the United States no choice but to punish Iran using military force. How do I know this? Hassan Rouhani, the president of Iran, stated that the sharp fall in global oil prices is the result of treachery. He was the only man to arrive at the truth. I agree with Prince Al-Waleed bin Talal that this will not go unnoticed by the American people and investors. Worst of all, is the effect on American families that depend on oil to pay their mortgages and feed their families. This is the opportunity of a lifetime to profit by buying oil stocks now. Due to these reasons, my price target for oil in the next two months is in the $85-$140 range.
I would like to thank Fiorenzo Arcadi for his contributions towards this article.
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. The author has no business relationship with any company whose stock is mentioned in this article.