Current OPEC members include the following: Algeria, Angola, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, the Republic of the Congo, Saudi Arabia (the de facto leader), the United Arab Emirates and Venezuela.
Up until the middle of the 20th century, the United States was the largest producer of oil and controlled oil prices worldwide. In contrast, OPEC controlled the oil markets and prices for most of the latter part of the 20th century. However, with the discovery of shale in the U.S. and advances in drilling techniques, the U.S. has re-emerged as a top producer of oil albeit with very high production costs globally.
Currently OPEC controls roughly 75% of the world’s total crude oil reserves and in 2019 produced 42% of the world’s total crude oil output. It also has the lowest production cost giving it real leverage over price and volume.
The USA has limited the OPECs pricing power by ramping up production whenever OPEC has cut its output. Russia has been public about its annoyance of this – as it appeared to be shifting the balance of power back in favour of the USA.
American reliance on imported oil provides OPEC with increased leverage to influence oil prices. When there is a glut of oil in the world, OPEC cuts back on its production quotas. When there is less oil, it increases oil prices to maintain stable levels of production. Plain and simple – open manipulation; business as usual. Even though it is price setting it has been an acceptable norm to the rest of the world. The US and Russia have fallen into line with the OPEC pricing decisions.
However, shale oil in the USA had challenged the pricing power of OPEC. The power that shale oil gave the US in price leverage has now evaporated. At $2.80USD production cost per barrel, Saudi oil giant Aramco has the lowest production costs in the world. In comparison, US shale oil production costs approximately $40USD per barrel. Right now with oil at $30USD a barrel, US shale oil companies are rushing to cut spending and rein in their production. (The issue is further complicated by the debt levels for shale oil companies).
The stage was set
The coronavirus caused an initial fall in oil prices due to the temporary closures of factories in China. This lead to a short term demand weakness for oil. Not from a lack of real demand – but due to factory closures. We saw evidence of factories resuming operations in the past week.
The opportunity for shale oil (and the US) to be attacked was wide open. Russia and OPEC were negotiating to “officially” lower production to keep the price high as has been past practice. Then Russia stepped back from OPEC negotiations. Oil dropped again.
But the most surprising move of all was by the head of OPEC, Saudi Arabia. They made the unprecedented move to increase production and cut prices themselves. This drove the stake into the heart of oil and had knock on effects to the stock market.
Just like that Saudi Arabia blindsided the whole of OPEC, Russia, America and the rest of the world. They declared a price war on every other oil producing nation.
Check mate USA
The US has been trying to get the world to use free market forces. Saudi Arabia just used “free market forces” against them.
We expect that shale oil will not be economically viable and as closures occur, oil prices will rise. Saudi Arabia, Russia and OPEC win at the expense of the shale oil (US). This keeps the balance of power away from the US.
At a surface level Saudi Arabia’s price war appears unintelligent. But this one move destabilises the US oil production and swings the pricing power over oil back to Saudi Arabia.
The contagion has spread from oil to everywhere. Literally throwing the baby out with the bathwater.
Stock markets have already taken the coronavirus out of perspective. Markets then added the fear of a global recession due to the oil price drop and plummeted to new lows. Whilst the market was overdone slightly with coronavirus, it has now totally overreacted with oil price wars.
We believe that once it is understood that the world isn’t in recession, the markets will see the path forward.
What happens now?
Longer term the oil price will be allowed to rise as Saudi grows its share at the expense of American shale oil. This has been a massive ruse for the history books.
Saudi Arabia and Russia turned a known set of normal events (OPEC meetings) into a manipulation – a fraud on the US and the OPEC cartel. We cant predict fraud – no-one can.
Due to the treachery in the oil market having such a broad-based effect, we now must adjust our expectations of how long the recovery to pre coronavirus levels will take. Instead of a sideways market with a quick recovery we see some positivity in the chaos near term and then a steady upward moving market.
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