By Kirk Spano
A lot of pundits have speculated that the price of oil collapsed because supply exceeds demand. As the Guinness beer commercials tell us, that is “brilliant!” Heck, I told folks in June oil prices were going to drop hard. So, while noticing supply and demand is a great Econ 101 observation, it doesn't answer the important question of why supply exceeds demand right now. We’ll delve into that in a moment, but perhaps an even bigger question is under what scenarios do we see a rebound in oil.
Many of the analysts and pundits agree that oil supply is greater than demand because of the hydraulic-fracturing boom in America. There is some truth to that, but it is not the heart of the reason. Despite the addition of American oil, there are other fields that are depleting. The U.S. has replaced much of the depleting oil, but so have other nations. In other words, drillers from different regions overlapped on replacing depleting oil, therefore, it is not exclusively America that caused the mini-glut in oil.
Some are suggesting that oil is simply so abundant that it is natural for the price to be lower than the range around $100 per barrel that it had been in for the past three years. That is nonsense. Economically viable oil starts to disappear for American frackers when it gets down to around $60 per barrel. Deep-sea oil is generally too expensive to bother with if the price of oil is below about $80 per barrel.
As I discussed in my last column, oil demand is around 92 million barrels of oil per day. While that demand is somewhat flat due to a slow global economy, we know that as more people around the world drive, especially in China where only about a quarter of the population drives now, demand will increase somewhat into the next decade.
In order to quench that demand, not only must the wells that exist keep pumping, but new wells must be added to replenish depleting wells. Adding new wells is not cheap. The amount of conventional low-cost oil on the planet is far below what is needed any longer, thus it is only a matter of time before oil shoots back up past $80 per barrel.
So, if all of that is the case, then how did current supply get almost two million barrels ahead of current demand? Simply put, it was allowed and encouraged to get there. That has happened for clearly geopolitcal reasons that only a few have pointed out.
In order to keep Russia from asserting itself in Eastern Europe and to get their help in reigning in Iran's nuclear program, it became obviously necessary a few years ago to put financial pressure on Putin. That is what is going on now for the most part, in my opinion.
On the geopolitical analysis site Stratfor.com , they have covered Russia's resurgence for several years now. They have also pointed out that Vladimir Putin might not be as untouchable as Russia's president as many believe. If Russia's oligarch billionaires get beaten up enough financially by western sanctions and low oil prices, they may react against Putin. Oil prices are lower today because the United States and Saudi Arabia are aligned on a lot more fronts than acknowledged by the press and lemming Wall Street analysts.
Eventually, oil prices will rebound. Probably a lot faster than many expect. This rebound will occur under three potential circumstances:
Russia capitulates on Eastern Europe and helps with Iran
There is a war or military event. This outcome is obviously horrible, however, it does not mean there will necessarily be a war with Russia. There could be a war within Russia or an overthrow. Billionaires can buy a lot of things, including generals. We could also see actions against Iran.
The U.S. and Saudia Arabia fold and broadly reduce production — there are some preliminary capital-expenditure cuts by majors Exxon /zigman2/quotes/204455864/composite XOM +1.76% , Chevron /zigman2/quotes/205871374/composite CVX +1.78% and Conoco /zigman2/quotes/207605056/composite COP +2.01% already, however, that is minor — while allowing Russia and Iran to continue their games.
I have the outcomes listed in order of most likely to least likely, in my opinion. My best analysis is that Putin cuts a deal by spring of 2015, but one way or another, I expect we will know which of the three outcomes becomes reality by the autumn of 2015.
While oil prices are low, and oil-company stocks are getting beaten up, we are actually seeing what is likely to be the last great chance to buy oil and gas stocks. That is what I have told subscribers at my American Resource Boom investment letter as we very slowly scale into about a dozen of the best companies and a few exchange-traded funds.
Between now and the time that the geopolitical implications play out, make sure to raise some cash and buckle up — it's going to continue to be a bumpy ride.
Disclosure: Kirk and certain clients of Bluemound do not own shares of any company mentioned. None are on Kirk's recommended list at The American Resource Boom Letter. Neither Kirk nor Bluemound clients plan any transactions in the next three trading days. Opinions subject to change at any time without notice.