To Invest or Not to Invest – That is the Question
By Mehran Ehsan
I am often asked the question by investors and industry participants: “How can we capture a guaranteed strength position in the oil sector through investments?” The simple answer is that you cannot. This is as cyclical of an industry as it gets.
What you can do is strategically participate when the commodity price is not “hot or inflated” and make sure the company or project you participate in has up to date feasibility and economic models at today’s price metrics, not for six months ago. This way, not only can you mitigate against price volatility but will capture a strong position by the time the prices correct and head back up, as history has shown over and over again.
You would have had to be hibernating if you have not heard of the oil price crash over the past six months; here is a few things that you might have missed up to May 2015:
· Geopolitics at its best between Middle Eastern countries such as Saudi Arabia and U.S. over market share in the oil sector.
· The ongoing unrest in the Middle East including Yemen and Libya putting disruption on oil movement.
· Iranian sanction relief protocols unfolding, as U.S. seeks to facilitate an agreement to curb the country’s nuclear intentions.
· Tensions between the West and Russia continue, including Russia’s increasing appetite to continue pumping oil at staggering numbers and staggering prices to Europe.
· Chinese demand in tandem with domestic production in China in fossil fuels fell short of analyst predictions disrupting the supply – demand balance.
· And yes, the U.S. hitting production numbers never seen before, and potentially becoming an exporter.
All of these aspects, combined with fundamental drives, such as supply and demand, fueled the sharp correction in the oil industry as of the last quarter of 2014 and we have all felt it one way or another. Now a few months into this correction, and we are seeing signs of relief and potential short term recovery.
Oil prices continue to show some strength, nearing their highest levels for 2015. Signs are pointing towards a more balanced energy market, with Brent hovering over $65 and WTI holding above $56 per barrel. The United States has had a decline in oil production for the third time in the last four weeks. This trend, and various geopolitical issues in the Middle East, have helped oil prices to hold at these levels.
The production as of April 17, 2015 in the U.S. is 9.36 million barrels per day, a decrease of approximately 22,000 barrels per day in the past few months. The Canadian producers are pushing through around 4.01 million barrels per day, a decrease of approximately 48,000 barrels per day in the same time frame.
There are over 4,000 wells suspended and sitting on the sidelines in the United States alone, waiting for prices to rebound in order for drilling companies to complete the wells and put them on pump. As these wells come online we can expect a further correction in pricing, although not a dramatic one. Another major aspect to take into account for oil price predictions is Saudi Arabia and its current production levels. They are clearly ramping up their production levels in order to keep pressure on high cost producers such as the United States. Currently Saudi Arabia has been producing at peak levels of ten million barrels per day in order to satisfy their market demand at such low oil prices and to counter non-OPEC sales by OPEC members.
Even in this environment, there are currently some positive drivers that may help oil prices recover this year. Among them:
· Major oil companies reducing future investment plans and cutting CAPEX;
· Further suspension of producing wellbores in North America that carry higher average cost of operating;
· A weaker US dollar;
· Sharp reduction in the US rig count to a three year low;
· Shorts being covered after short positions have doubled in the past few months;
· Reduced supplies from Libya, Yemen and Iraq as fighting intensifies;
· Investors injecting more than $2.4 billion into the energy ETF’s since January 1, 2015.
As oil industry experts know it all too well, after three years of high and deceptively steady oil prices, the recent drop is a bold reminder that the norm in any commodity market (especially the energy markets) is of a cyclical nature in itself, and continues to change. It is of importance that one looks through the short term volatility in order to capture the long term trends to their advantage. Do not be fooled by the short term corrections in this market; as we have years of catching up to do to balance the fundamentals between supply and demand.
Predicting the future in such a cyclical commodity needs to be done carefully, beyond the fundamentals and geopolitics, considering all externalities. I believe OPEC nations still to this day have a huge influence on the prices and safeguard their market share. However, one thing that most people are not aware of is at what price is OPEC’s market share safe and they don’t have to worry about it? The magic number sits between $60 - $80 per barrel.
To give you some perspective on this, it took prices of more than $100/bbl for a couple of years before OPEC's share started to slip. In the early eighties, OPEC put price before market share, their market share collapsed from 45% to less than 30% in less than five years, and they reaped two decades of low prices before demand growth outstripped supply growth and finally tilted market power back into the producers' hands.
OPEC is not going to repeat the errors of the early eighties. They have decided that maintaining market share matters more than price, and if it takes a year or two of low prices to protect their market share that is just what OPEC will do. However, if OPEC can build market share at $60 to $80/bbl, why on earth would they let oil trade at less than $50/bbl?
Oil Price Prediction: with ownership in oil and gas fields across different States in the USA and Provinces in Canada, Energy Resources Corp is continuously monitoring aspects of this market and having this information we are able to predict a stable correction in prices to increase them to $60 - $75 per barrel for Brent crude by the first quarter of 2016. (It is worth noting we are predicting this at the date of writing this article May 1, 2015).