While we’ve all been focusing on events in Europe and China recently, the oil price has been quietly sliding.
Since late March, the Brent Crude Oil price is now down by 16% to $106 / barrel.
A falling oil price is good news for the global economy, of course. Expensive oil has a habit of causing recessions — so cheaper oil takes the pressure off slightly.
But it’s bad news for investors in oil companies, because in the last few months stock prices have come off the boil.
So what’s behind the sharp pullback in the oil price? And is the price set to fall further? Read on…
One big reason for this is that the global economy is slowing down.
And this has seen the oil price fall 20% in recent weeks:
Europe’s economy is within a hair’s width of recession, the USA is decelerating, and China’s economy may be in the process of stalling as we speak.
The ‘red-cordial’ effects of their respective stimulus boosts are fading from these three engines of the global economy, and all at the same time. As economic growth slows, so does oil demand.
The bigger reason for this fall in oil prices is an increase in Saudi oil production.
Earlier this year the Saudi Oil Minister, (who spoke at the APPEA conference I recently attended), announced a target price of $100 / barrel.
So when prices soared to $125 / barrel, they actually wanted prices to FALL. Why? They can’t get greedy, because high prices make people look for alternatives, which is no good for them in the long run. And as the biggest oil exporter, Saudi Arabia can bring oil prices down if they want.
But, while Saudi Arabia has long claimed it could crank up production significantly…it has never actually done it.
I’ve taken a few pot shots at them to this effect recently — though I’m in danger of having to eat my words. The International Energy Agency (IEA) just announced that last month Saudi Arabia has pumped an average of 10 million barrels of oil a day. This is the fastest rate in 30 years. And the IEA reckons the rate is set to increase again this month.
So does this mean oil prices are about to fall further?
The High Cost of Oil
It’s very unlikely. The cost of producing oil has increased significantly. With these high costs, if the oil price falls too far, producers stop making money. Saudi Arabia has to set their export levels just right to avoid this.
Sabine Schels, Senior Director and Global Commodity Strategist at Bank of America Merrill Lynch, reckons bringing one barrel of OPEC oil to market now costs $80-90 on average.
If OPEC’s costs are really that high, then there’s no way we will see oil prices coming down much lower than their current level. In fact, if you look at the chart above, you can see the price bounces each time it gets anywhere near the $100 level.
$80-90 is a far cry from the $10-$15 production costs that once existed. There are two big reasons for this.
Firstly, the Saudi’s are using more sophisticated — and expensive — methods to increase the recovery rate from wells. These wells are now past their prime, so it takes more input to get them to flow.
I expect this is why they increased their oil target price just before they were able to achieve a 30-year high in production.
The second reason for the higher cost to get ‘one barrel of oil to market’, is that this probably includes all of Saudi Arabia’s fiscal costs.
By this I specifically mean spending by the government to keep its citizens happy. Since the Arab Spring, this has increased massively.
What this all adds up to is this: as long as Saudi Arabia is the dominant oil exporter, we can expect oil to stay above $100 / barrel.
And barring any major oil shock — like the closure of the Strait of Hormuz — we probably won’t see the oil price soar much above $125, for time being. The Saudis have shown they mean business about keeping the price from rising too far.
This sets a benchmark range — and importantly it creates an opportunity for anyone that can undercut it.
There are over 100 oil and gas stocks on the ASX. Some are exploring conventional energy onshore, and some are offshore in places like Brazil, and East and West Africa.
We also have a growing number of unconventional plays exploring opportunities in shale oil and gas for example. Some are in the US, which has the most mature stocks in this field. We also have a cluster of Aussie stocks looking at unconventional oil and gas right here in Australia.
Share prices have already soared despite there being more challenges than results at this stage — but there are still a few flying under the radar and yet to take off.
It’s a market rich with opportunity. In a difficult stock market, it is one of the few areas we can be confident of making money in this year.
Alex Cowie
Editor, Diggers & Drillers
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