This month, Saudi Arabia sent oil prices lower by announcing an increase in production.
Oil prices dropped below $50 per barrel on the news. Since the initial pullback following Saudi Arabia’s announcement, WTI crude oil has been trading in a range of about $48 to $50.
Here’s why this is so important…
As you probably know, Saudi Arabia has been trying to manipulate the oil market since mid-2014.
Originally, Saudi Arabia purposefully sent oil prices into a death spiral in an attempt to put U.S. shale oil companies out of business. The idea was to push oil so low that U.S. companies couldn’t compete. And this would allow the Saudis and OPEC to corner the oil market.
It didn’t exactly work out that way.
What happened instead is that U.S. shale drillers got innovative. And that innovation allowed them to drill wells more cheaply.
Over the past year, the cost of shale fracking has steadily declined. Today, U.S. companies enjoy a very low “breakeven cost” when drilling for oil in the largest shale formations in the U.S..
Check out the chart below to see how these costs have declined over the past three years.
Source: WSJ’s Daily Shot
So instead of putting the U.S. oil industry out of business, Saudi Arabia essentially gave U.S. oil companies the incentive to become more innovative, more efficient, and to produce oil at cheaper prices.
That’s great news for the U.S. shale oil industry!
Last month, Saudi Arabia increased oil production by 2.7% to 10.011 million barrels per day.
By increasing production in February, Saudi Arabia was boosting the supply of oil on the global market. We know from Economics 101 that the more supply of a commodity, the lower the price.
The financial media loves to tout how Saudi Arabia is the second largest global oil producer. Only Russia produces more oil than Saudi Arabia. So when Saudi Arabia increases production, the talking heads on CNBC and Bloomberg Television make a big deal about it.
But the bottom line is that Saudi Arabia has already tried this move.
In 2014, oil was trading near $120 per barrel. Ramping up production had a big effect on global oil prices. But today, Oil is trading at less than half of that level. So I don’t expect oil to move much lower than its current range.
More importantly, U.S. oil companies are not nearly as vulnerable as they were two years ago. The chart above shows you how cheaply these companies can produce oil and still turn a profit. Plus, the weakest oil companies have already been shut down or acquired during the 2014 / 2015 bear market for oil.
The U.S. oil companies that are left represent the strongest and most resilient operations. Which means Saudi Arabia is very unlikely to capture much market share by boosting production.
After all, Saudi Arabia can’t live forever with low oil prices…
The country has bills to pay. It’s burning through cash at an alarming rate. And if oil prices remain below $50 for an extended period of time, Saudi Arabia won’t be able to survive.
That’s why I don’t think Saudi Arabia’s will continue to increase production. And I don’t think this move will have a long-term effect on oil prices.
So if I’m right and the price of oil doesn’t have too far to fall, what’s the best way to take advantage of today’s lower oil market?
Investors are going to find some of the safest and most lucrative oil investments not in the stock market, but instead by purchasing corporate bonds.
How do I know?
Because I’ve already shown investors how to lock in tremendous profits from energy-related corporate bonds.
Investing in oil-related bonds is very different from investing in oil-related stocks.
Yes, they’re both affected by the price of a barrel of oil.
But stock investors live and die based on the profits that each oil company generates. More accurately, stocks move higher and lower based on what investors expect profits to be. And you and I both know that traditional investors can be fickle animals.
Oil stocks in general are more speculative and can have more risk.
Corporate bonds, on the other hand, come with a company guarantee. by law, oil companies are required to pay semi-annual coupons to their investors. And when the bonds mature, the company must pay you $1,000 for every bond you own.
That legal requirement is why bonds can be much safer — and much more lucrative investments for energy investors. Especially if you pick your bonds up during a down market.
Case in point:
In April of 2016, when oil was trading near $45 per barrel, I recommended buying the bonds of EP Energy – a U.S. oil producer. Since investors were worried that lower oil prices would hurt energy companies, we were able to buy these bonds at 51-cents on the dollar.
That means every $1,000 bond only cost us about $510.
Fast forward to today, and those bonds are trading closer to 90-cents on the dollar. Meanwhile, each bond has paid us $93.75 of income as well.
EP Energy bonds aren’t the only bonds we’ve been able to do this with. We’ve made similar plays with Clayton Williams, Resolute Energy, Bill Barrett and other oil producers as well.
The key to making money from energy corporate bonds is to buy these income investments in a down market for oil. This way, you’re more likely to pick up the bonds at a discount.
Then, you can sit back and collect your income payments, knowing that both your income and the investment value of your bond is protected by a legal guarantee. As long as the energy company stays in business, they’re legally required to pay you!
I’m keeping a close eye on the oil market, and on the moves that Saudi Arabia is making to manipulate oil prices. My guess is that over time, Saudi Arabia will be unable to affect oil prices as much as they have been able to in the past. That’s because U.S. oil production is picking up, and capturing a bigger chunk of the global oil market.
Once it’s clear that oil prices are firming, we’ll be hoisting the buy flag on other resource based opportunities.
Here’s to growing and protecting your wealth! – Zach Scheidt
Fears of a global oil glut have returned to sink oil prices in March, but two fund managers argue that supplies are much tighter than traders realize. They expect oil prices to roughly double, to $100 a barrel, within a year.
Prices for oil trade around $50 a barrel and recently set lows for the year, but that doesn’t worry Leigh Goehring and Adam Rozencwajg, managing partners at Goehring & Rozencwajg Associates.
“We’re actually more bullish than we were before,” said Goehring, in an interview with MarketWatch.
“The underlying fundamentals of what we‘ve outlined for everyone…are happening right in front of us and yet people are becoming more and more bearish, so you’re setting yourself up for a very, very big, positive surprise,” he said.
Goehring and Rozencwajg, who launched a natural resources fund in January GRHIX, -0.21% GRHAX, -0.32% made their call for $100 oil in 2018 late last year when the Organization of the Petroleum Exporting Countries reached an agreement with other major producers, including Russia, to cut production.
The November announcement of the OPEC-led deal, which officially kicked in at the start of 2017, helped fuel strong gains in the last two months of 2016. West Texas Intermediate crude CLK7, -0.48% gained 45% last year, while Brent crude LCOK7, -0.02% jumped by more than 50%.
The OPEC pact draws parallels to a production cut announced in 2006, Goehring and Rozencwajg said. “They didn’t need to cut back then” and they don’t need to cut this year, said Goehring.
WTI crude spiked to more than $145 a barrel in July 2008.
In 2006 to 2008, the OPEC cut “tightened the market that had already tightened on its own. It was too much tightening,” Goehring said.
The “same thing’s happened again—the market tightened on its own in 2016,” he said. OPEC has cut production, “now we’re going to see too much tightening in 2017.”
The biggest reason Goehring and Rozencwajg expect to see $100 WTI and Brent crude oil prices in the first quarter of 2018 lies in their analysis of data from the International Energy Agency.
The IEA reported an oversupply of crude oil for 2016, but G&R research shows a discrepancy between the global inventory picture and the global supply and demand data the Paris-based agency provides, Goehring and Rozencwajg said. That’s what Goehring referred to as “missing barrels.”
The IEA’s December oil report estimated that 2016 global oil supply was at 97 million barrels a day and global demand was at 96.3 million.
That suggests that the market was oversupplied by a “very large” 700,000 barrels a day for full year 2016, Rozencwajg told MarketWatch. “If you think that’s true, then you should think that inventories over the course [of the year] would’ve…built” by 700,000 barrels times 365 days in the year, or more than 250 million barrels.
But industry and government-controlled oil inventories from the Organization for Economic Cooperation and Development were actually down in 2016, he said—falling by roughly 7.6 million barrels over the course of last year, based on figures from the IEA.
The latest March oil report raised the 2016 global demand estimate to 96.6 million barrels, with the IEA effectively lowering its oversupply estimate to about 400,000 barrels a day.
OPEC felt that 2016 was oversupplied and would get worse in 2017, said Rozencwajg. But he believes the oil market likely shifted into a deficit in 2016, as measured by the OECD inventories falling year-over-year.
The market will “become massively undersupplied in 2017 and price should rise,” he said.
The IEA accounts for supply and demand discrepancies by using “miscellaneous to balance” figures.
Matt Parry, a senior oil market analyst at the IEA, explained to MarketWatch that the miscellaneous to balance figure “”represents a combination of the non-OECD stock changes and missing barrels in the demand and supply numbers.”
In the past year, he believes the non-OECD stock changes played a more significant role, noting that China has seen big changes in its stockholdings recently as it builds strategic reserves and has tried to take advantage of what it perceives as historically low prices.
“The IEA is striving to get a better handle on non-OECD stocks and if we did, we could [likely] greatly bring down the ‘miscellaneous to balance’,” he said.
These countries, however, don’t have an obligation to report to us, said Parry. “Indeed, business incentives in storage often favor secrecy.”
Parry said he wouldn’t be surprised if the supply and demand forecasts are revised 12 times a year. “The revisions are generally small each month, although they can add up if they are consistently in the same direction.”
This chart, compiled by The Wall Street Journal with data from the IEA, show what the Paris-based agency’s forecasts were in January of each year since 2010, and what the latest estimates for those years were in the March IEA oil report. For 2016, there was a revision of nearly 902,000 barrels.
The IEA’s estimates of global crude demand have been upwardly revised by an average of 880,000 barrels a day for the past seven years, according to a Wall Street Journal analysis.
For this year, the IEA forecasts demand of 96.6 million barrels a day, but Goehring and Rozencwajg expect to see further revisions to the number.
“We go to great lengths to try and figure out what are those missing barrels, do they really exist and are they truly missing or do they exist at all,” Goehring said. “We believe, based upon our research and our demand models…that those IEA demand numbers are understated, and if you were to bring those numbers up to what we believe are the correct demand numbers, that those missing barrels would go away.”
“It paints a completely different world of what oil looked like in 2016 versus what [the IEA] said,” according to Goehring.
Here is what the IEA revisions over the years look like to Goehring and Rozencwajg:
“The IEA in their last several announcements have gone through severe revisions of their 2016 data,” said Goehring. “ And they’ve basically made a huge amount of those missing barrels go away.”
“What have they done? They’ve revised significantly upward their 2016 oil demand” forecast, he said. – Myra Saefong
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