Ur-Turn: The Truth About Oil, Part Two – The Good, The Bad, And The Ugly
In the 1966 Spaghetti Western classic The Good, the Bad, and the Ugly, the three principal characters come together in what is considered the most iconic standoff in cinematic history. Three parties hostile to each other and the first one to shoot is the most likely loser.
At no time in modern history has the overall global economy been so good and the commodity price of oil crashed so fast, and so hard. As of this writing short contract West Texas Intermediate (WTI) is below $46 USD a barrel with no sign of price support. We are deep into market crash territory with pumping out of the ground tipping over into a money losing proposition. OPEC nations, state producers, and global multinationals have each other in check on the world chessboard, and no one wants to move their pieces.
Although there are plenty of conspiracy theories on why the price of oil has declined so fast, it is the simple economics of supply and demand. Production over capacity has bloated from 700,000 barrels a day this summer to 1.3 million barrels. Although there is a growing list of drilling rig contract cancelations, existing production sources are pumping more. Over supply will continue to grow because the three goliaths of oil production (OPEC nations, state owned and corporate producers) are fighting to cling to their existing market share at any cost.
Russia has increased production through 2014 despite a battered Ruble and the price of oil sitting at less than half of where it needs to be to support the Russian government. Russian producers are hoping to capture more market share, ironically from the same western European nations that Moscow is growing increasingly resentful of, to help bolster overall revenues. The Putin government position to the Russian people is the price decline is an economic assault on their nation. This message resonates well outside of major population centers, but dissatisfaction and fear of a 1998 grade collapse are growing.
Vladimir Putin has enjoyed high approval ratings because the standard of living has improved dramatically under his leadership. For Putin to maintain power, he has to keep the Russian economy out of collapse and cannot permit a repeat of 1994 and 1998. Eleven-percent inflation, 17% interest rates, and a three-trillion Ruble budget deficit projected for 2015 is a tough hill to climb. Although the General Motors strategy of, “we’ll make it up in volume,” is folly, it keeps people employed and revenue flowing.
Saudi Prince Alwaleed bin Talal has stated that Saudi Arabia will not reduce production regardless of the direction of the market, and that oil will never be $100 barrel again. The reason behind this is the wellbeing of the Saudi royal family and the viability of the Saudi government is interdependent on national prosperity.
Compared to their neighbors, Saudi citizens enjoy a higher standard of living, which makes the average Saudi less likely to want to overthrow the existing, western friendly government. During the oil crashes of 1986 and 1998, the OPEC cartel, led by Saudi Arabia, agreed to reduce production capacity to help stabilize oil markets. A number of OPEC nations cheated and didn’t cut production, causing Saudi Arabia to permanently lose market share after each correction. Although you can make a strong case that the Saudi government turns a blind eye to those who fund radical Islam in other parts of the world, they are showing little interest in allowing it to ferment inside their own borders. For the Saudi royal family, heads could literally roll if their influence in the global oil market is lost.
In the Powder River Basin, Eagle Ford, Bakken, and the oil sands of Canada, leveraged producers and corporate interests are looking for long term return on investment, and increasingly economic survival. A growing list of analysts are saying that Texas should prepare for a recession, and the gravy train of $30 an hour day labor jobs in North Dakota are coming to an end. Smelling blood in the water against the other large producers in the world, the strongest players believe they can keep the pressure up until someone cuts production, and capture the smaller producers as they consolidate.
In prior oil crashes, ExxonMobil, BP, Chevron, etc. have treated commodity weakness as buying opportunities. Because major oil corporations are morphing into energy companies, are vertically integrated, and have record cash reserves, they can carry out a long term war of oil price attrition. The contract drillers, their suppliers, rig operators, and the support network are already reeling from the price collapse, but with a dividend yield of more than four-percent for blue chip oil stocks, shareholders will remain patient, for now.
No one wants to give up market share because no one can afford to give up market share. If anyone cuts production, the risk is becoming irrelevant in this post oil crash market. Anyone who yields market share today, yields it forever.
To get an idea of how much global production has grown, the U.S. Energy Information Administration (EIA) has tables of data you can download for fun and profit. Since 2008 US oil production has almost doubled. From September 2010, when the Great Recession started to wind down, to September 2014, US oil production has increased 31%, making the United States the largest oil producing nation in the world.Top Five Oil Producing NationsCountryProduction (thousands of barrels per day)Four Year Increase/DecreaseUnited States14,24630.80%Saudi Arabia11,5583.98%Russia10,5643.65%Canada4,61227.86%China4,470-0.03%
Source, USEIA – http://www.eia.gov, as of September 2014
Of the top ten oil producing nations, only Iran has had a statistically meaningful decline in production during the last four years. Recent reports of United States oil production growth slowing to the lowest level in 5 years makes for great headlines, but when you’ve grown 90% since 2008, you reach a point where deceleration is inevitable.
At the same time of this unprecedented expansion in production and the complex geopolitical situation of radicalization and militarization, oil consumption growth has dropped to just 2/10 of a percent through 2013. More remarkable, although all the data isn’t available, it appears for 2014 global consumption increases has flattened to zero, and may have even retracted.
China is expecting to grow by a relatively tepid 7%, India has cut their growth forecast in half, Japan is expected to be flat, and Russia is expecting to contract by 3%. Although the United States is enjoying strong GDP and job growth, conservation programs and increasingly stringent CAFE standards are having a real impact on consumption. In the January 13, 2015 short-term energy outlook released by the EIA, global consumption is expected to grow 900,000 barrels per day through 2015, even when factoring increased US gasoline consumption forecasts.Top Five Oil Consuming NationsCountryConsumption (thousands of barrels per day)2012 to 2013 Increase/DecreaseUnited States18,9612.55%China10,1161.37%Japan4,530-3.49%India3,5091.71%Russia3,320-2.21%
Source, USEIA – http://www.eia.gov, as of 2013
2015 is shaping up to be the 1967 of this generation. We are in a golden age of power and efficiency. Three-hundred horsepower is commonplace and 500 reliable horsepower, or more, is obtainable to a wider demographic than at any other time. Buyers can choose from the Charger, Challenger, Mustang, Camaro, Corvette, or SS if they want to get their ‘Merica old school V8 rear-wheel-drive on. The Hellcat, Shelby GT 350, magnetic ride control and manual transmission equipped SS, and C7 couldn’t have come at a better time. Never mind an almost endless list of sedans, CUVs and SUVs with performance numbers that makes a 1967 GTO gimpy in comparison.
Many who didn’t learn to drive in the Detroit malaise and British Leyland era believe a traffic ramp sprint to 60 MPH (or 62 KPH if you please) that takes longer than eight seconds is dangerously slow. The fears of a performance Armageddon driven by stringent global fuel economy standards appears to have been completely unfounded (your author, guilty as charged). A growing list of states is raising interstate speed limits and consumers are enjoying at least a short term gain in disposable income.
The love affair North America has with fullsize trucks will continue unabated, and will accelerate this year. Manufacturers with strong CUV and SUV line ups can look forward to growing demand in 2015, while mainstream subcompact, compact, and midsize sedan sales will slow. Think Jeep had a good 2014, wait until you see 2015. The General Motor twins of the Colorado and Canyon, as well as the Chevrolet Trax are, for the short term, ill-timed. For Ford, 2.7 liter Ecoboost engines in aluminum fullsize trucks might not be as strong a selling point if gasoline had taken a path in the other direction. For the growing list of diesel powered cars, trucks, and SUVs that United States buyers can choose from, the timing couldn’t be worse. The premium both in Average Transaction Price (ATP) and at the pump for diesel means that the math simply doesn’t add up.
But what about those cars which aren’t powered by gasoline, or are only partially powered? Tesla continues to benefit as a boutique luxury brand, and should be immune from current conditions. The Toyota Prius line up will further decline year-over-year in 2015. Low gasoline prices coupled with low ATP on Camry and Corolla makes the Prii a tougher sale. Chevrolet Volt version 2.0 is appearing at the wrong time. The Toyota Mirai should be immune to market conditions because of its green credentials and the future is now hydrogen fuel cell driveline. Because of its early adopter cred, the Mirai is likely a bigger threat to Tesla Model S sales than gasoline under $2 a gallon.
So what about the price of oil? With consumption growth not outstripping production through 2015 barring some huge unforeseen event, the price can only go down. History indicates the lowest it could go is about $23.50 a barrel, which when adjusted for inflation, is at the 1986 basement. I see oil finding support at $28 a barrel in the summer of 2015, and gasoline future dropping below $1 a gallon USD. The Midwestern states which typically have lower motor fuel costs could see the average price of regular gasoline hit $1.50 a gallon by the start of the summer driving season.
If you were thinking about a cross country road trip in a Challenger Hellcat, this is the year to do it.
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