OPEC’s Battle and Cheap Money
US natural gas has taught us this: In this era of free money, prices can stay below the cost of production a lot longer than anyone imagined years ago.
When cheaply borrowed money leads to overproduction, which leads to excess inventories despite rising demand, prices plunge to ludicrously low levels. And if borrowed money keeps pouring into the sector to keep existing investors afloat, drillers continue to overproduce because they have to in order to get even more new money to service the pile of existing debt, thus piling up even more debt and causing the price to get hammered down over and over again.
The price of US natural gas collapsed in 2009 and, except for a few brief episodes, has remained below the cost of production ever since. Now that investors are finally turning off the spigot, persistently negative cash flows can no longer be funded with new debt. Two major drillers have gone bankrupt this year. And the second largest natural gas driller in the US, Chesapeake, is headed for deep trouble.
But this is six years after the price collapsed. Tens of billions of dollars from investors have been drilled into the ground to never be seen again. And the price of natural gas is still below the cost of production, as production hit new records.
The oil market is different because it’s global and more geopolitical. But as with US natural gas, it ends up being about money and production. Production will go down only when the new money dries up. That hasn’t happened yet except on the riskiest fringes.
OPEC increased output in 2015. Gains led by Iraq and Saudi Arabia
- OPEC made its now famous decision in November 2014 to leave its production target unchanged at 30 million barrels per day (mb/d). Since then, the group has consistently exceeded that target.
- In October, OPEC produced an average of 31.76 mb/d, well in excess of the stated quota.
- The production gains made since last year have almost entirely come from Saudi Arabia and Iraq, each adding around 500,000 barrels per day.
OPEC fighting for Europe market share
- News reports have documented the battle for market share in Europe between Russia and Saudi Arabia. Saudi Arabia’s increased exports to Europe are pushing down the price of the Urals blend, the benchmark price that Russian oil sells for.
- However, Iraq has also dramatically increased oil exports to Europe.
- Saudi Arabia and Iraq have benefitted from Iranian sanctions. Increased market share came from the 1 mb/d that Iran used to sell to Europe.
- Iranian exports are set to begin again soon. Battle for market share in Europe will intensify, likely pushing down prices.
Record Oil storage levels
- Crude oil inventories are rising around the world (see black line on charts above).
- Swelling storage points to ongoing glut in supply, not enough demand.
- Until stocks draw down, unlikely oil prices will rebound.
Reported by ISA Intel via Oil & Energy Insider. But beyond these types of crude oil inventories, there is another type of oil storage: fully loaded tankers anchored offshore, waiting for the oil price to rise.
How many of these tankers are there? Bob Miller, author of several books, including Kill Me If You Can, You SOB, sent me his first-hand observations from a 33-day cruise he’d taken from the Eastern then Western Caribbean, through the Panama Canal and on to Canada.
Both St. Lucia and Aruba were loaded with ships. I think we pulled into every deep sea port in Mexico on the way. We actually had to work our way through them to get into some ports. I have taken two world cruises and have never seen this many cargo ships at anchor. They reminded me of WWII pictures of supply ships.
At first it was only the guests who were talking about all the tankers anchored offshore wherever we went. I guess the captain was asked about this so many times that he decided to make a public announcement. He said that most of the tankers were from Saudi Arabia and were having to wait until storage tanks were low enough to unload.
One big tanker had a sign that read, “Arrived 4/12/15. God only know when we’ll depart.”
This speculative inventory of crude oil is lurking everywhere, ready to be dumped on the market without notice as soon as prices rise far enough, or when speculators are forced to sell, practically guaranteeing that prices will get hammered down over and over again. And how low can the price of oil go under these conditions? To ludicrously low levels – just like US natural gas.
So is this the Death of the Petrodollar? Read… Petrodollar Reflux to Hit Treasuries, Other Assets
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.