Investors keep hoping the Saudis don’t know what they are doing.
By Kurt Cobb, Oilprice.com
The $9.2 billion investors paid to snap up new equity offerings from U.S. oil companies in 2016 proves those investors are indeed ready for more punishment.
The amount is in line with the pace of such equity offerings in 2015 even as the mood in the oil markets has grown increasingly dour. In June of last year I wrote:
New investors in U.S. oil company shares must believe they are catching the bottom and will have a very profitable ride up from here. This demonstrates that OPEC’s work is not done and accounts in part for the decision to leave production quotas unchanged. OPEC’s next task is to convince those making new investments in oil that, rather than catching a bottom in oil prices, they have caught a falling knife.
A lot of investors did end up catching a falling knife as oil careened downward from about $60 a barrel last summer to Friday’s close of about $36. Investors this year may still find that the knife is falling, though it admittedly doesn’t have as far to fall this time around. Still, it seems they misunderstand OPEC’s strategy or believe that that strategy will fail. As I said in the same piece:
The cartel must dampen enthusiasm for investment for the long term if the organization’s members are going to benefit. A crippled U.S. oil industry without friends in the investment world is the only way to assure that rising prices won’t simply lead to a stampede back into U.S. shale deposits.
It seems that the oil industry still has friends in the investment world and that OPEC’s work is therefore not yet done. The big question then is: Will OPEC stay the course or relent with a production cut this year to raise prices?
I doubt that OPEC will relent. As bad as the OPEC countries, including Saudi Arabia, are hurting, to give up at this point would make all the previous suffering pointless. Saudi Arabia is really the linchpin in OPEC. No member can resist the will of the Saudis because they control such huge and flexible oil flows.
I have posited a speculative, but nevertheless plausible reason for why Saudi Arabia may not give up on its strategy any time soon: The kingdom may be at or near its all-time maximum rate of production, a rate it may only be able to maintain for the next decade or so. Naturally, the Saudis want to maximize their revenues during this period of peak production. They can’t do that if U.S. oil companies keep overproducing.
If the Saudis can neutralize those companies, by bankrupting them or forcing widespread lease sales, this will allow major international oil companies to buy up much of these distressed assets. The majors will develop these properties more slowly than the independents did because 1) the majors do not have to worry about their ability to meet debt payments and 2) the majors do not want to crater the price of oil which would only undermine the value of their newly acquired leases.
It is hard to imagine that the Saudis launched their low-price strategy on a wing and a prayer without thinking through how long it would take to force other producers to stop overproducing. But, investors keep hoping that the Saudis don’t really know what they are doing.
So far the Saudis appear to have the upper hand, and I’m guessing that those buying newly issued oil company shares these days are miscalculating once again. After all, the funding derived from these share offerings will only serve to encourage continued overproduction by making it possible for producers to hang on that much longer in hopes of an upturn. By Kurt Cobb, Oilprice.com
It’s a sign of how bad things are that we feel optimistic about $35 oil. Read… Oil Fundamentals Deteriorate, Prices Should Fall Hard
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.