The Inevitability of Oil Profits
Last November, I wrote an article about how much I loved commodities — especially oil.
Crude was trading at something like $37 per barrel at the time.
Here's what I said:
I saw an article today predicting $26 oil.
I would love to buy some $26 oil.
See, with commodities, it's all about the cycle. It ebbs and flows almost predictably.
When oil crashed to $30 per barrel in 2008, I bought it. When it climbed back over $100 in 2012, I shorted it. I had to wait about two years, but eventually, prices collapsed once more.
Now, I'm looking to buy once again.
As we stand here today, oil is trading at $47 per barrel.
Did I invest in oil companies back when I said I would?
Did those investments go up?
So did the companies I recommended to you, our readers, in my 2016 Oil Outlook.
Exxon (NYSE: XOM) is up 20% over the past year. And Magellan Midstream Partners (NYSE: MMP) is up about 30% in that time. They've also yielded some juicy dividends along the way.
Now, am I bragging? Am I saying I'm a genius for recommending two of the biggest, most well-known energy companies in the world?
I'm not a genius. At all. Ask my girlfriend and she'll tell you I'm not even that smart.
I just understand commodity cycles. Better still, I have a strong grasp of fundamental concepts, like supply and demand. And that's really all it takes.
That's the whole promise of the Outsider Club — that you don't have to be a genius, or a professional to make money investing. Anyone can do it.
Furthermore, there's still more profit to be had in oil. And that's really why I'm writing this today.
As you're probably aware, OPEC has finally agreed to cut production after two years of going hog wild at the pumps.
To be clear, this is not to say that it's all sunny skies ahead for oil and other such investments. It's a volatile commodity. But we've definitely turned a corner.
OPEC's Big Decision
As I noted last year, this decision by OPEC was inevitable for one simple reason: Members' budgets demanded it.
Oil accounts for a whopping 92% of Saudi Arabia's budget. As a result, the Kingdom needs oil at $106 per barrel for its budget to break even. The only thing that's kept the lights on in the desert Kingdom these past few years has been its huge stockpile of currency reserves.
Still, there's no hiding from low oil prices when crude production accounts for 57% of your GDP, as it does in Saudi Arabia. Beyond that, oil accounts for 30% of Iran's GDP, 30% of Kazakhstan's, 49% of Angola's, 42% of Oman's, 56% of Iraq's, 46% of Libya's, 30% of Algeria's, 67% of Congo's, 21% of Russia's, and 21% of Venezuela's GDP.
Many of these countries also choose to spend that oil money, rather than bank it.
Nigeria needs oil at $122 for its budget to break even, Venezuela needs it at $117, and Iran needs it at $130 per barrel. Russia, the largest non-OPEC producer, also required $100 oil to buoy its budget, as it labors under sanctions.
So OPEC finally broke, agreeing to reduce production to 32.5 million barrels per day from about 33.2 million in August.
The deal struck wasn't written in stone. It's more or less a “gentlemen's agreement” that still has to be ratified at the group's next meeting.
But it's a start.
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The reality is OPEC can't keep pumping at current levels when there's such a big glut on the market.
We can reasonably expect that from here on out, OPEC production (and thus global production) will go down. We don't know how far output will drop, or at what pace. But it's now clear that the cartel is intent on pushing prices higher.
That makes sense.
If you remember, this whole thing started because Saudi Arabia wanted to hamstring American production by driving high-cost frackers out of the market. And it's done just that.
Roughly 100 North American oil and gas companies have filed for bankruptcy since the start of a two-year oil price rout. And the industry may be only halfway done. Oil prices still aren't high enough — and they won't rebound quickly enough — to bail out highly-indebted producers.
As a result, U.S. oil production is on the decline following years of increases.
A look at the latest report by the U.S. Energy Information Administration shows U.S. oil production is down more than 1 million barrels per day since its June 2015 peak of 9.6 million. As of Sept. 9, U.S. oil production is at 8.5 million barrels per day. That’s an 11.5% drop in production in a relatively short period of time.
The bottom line: Between OPEC cuts and U.S. bankruptcies, production is headed downwards.
Therefore, the price of oil is likely to rise, barring some global catastrophe. (I'm not ruling that out, by the way, just saying it's not likely).
As I said, a year ago oil prices were hovering around $37 per barrel. Today, they're close to $50. And it's reasonable to expect that they'll be at $60-$70 per barrel sometime in 2017.
That's just the way commodities cycles work.
There are both boom and bust cycles.
Oil just took another big step out of a bust cycle.
Jason Simpkins is a seven-year veteran of the financial publishing industry, where he's served as a reporter, analyst, investment strategist and prognosticator. He's written more than 1,000 articles pertaining to personal finance and macroeconomics. Simpkins also served as the chief investment analyst for a trading service that focused exclusively on high-flying energy stocks. For more on Jason, check out his editor's page.