This Coronavirus thing impacts everything. The oil market is no exception. I’ve committed to some pretty strong predictions about the future of the oil market and how it means the end of the current regime in Saudi Arabia. I still stand by all of those predictions, but it’s hard to say whether this current crisis accelerates the timeline, or slows it down. Starting March 6th, Saudi Arabia went to war against every other producer in the world.
I believe that the US oil industry will be the most prominent victim. The sustained period of low oil and gas prices we are about to experience may bring us to an inevitable future more quickly. Saudi Arabia will be the last oil producer. The crucial question remains the price at which they are able to sell that oil for. It’s now possible to envision a future where Saudi Arabia controls price again… but only briefly. Today’s video explains…
Video Transcript after the jump…
Hey there. Last time I pointed out that after the easy ten year summer of the Obama expansion, the business winter of Coronavirus has arrived. Today we are going to look at the weakest and most poorly prepared of all the world’s markets, the oil and gas market. There’s a lot of hoopla around this industry, from Trump crowing about energy dominance, to Saudi Arabia’s many promised mega cities in the sand. Those of us who follow the market, and those of you who follow this channel know a different story. Winter is no longer coming for oil and gas folks. Winter is here.
To understand the extraordinary 30% price drop that oil experienced last week, and the fact that it’s lost fully half its value from a year ago you have to understand how very sick and weak the oil market has been for years. Since 2016 the worldwide oil and gas industry has been artificially propped up by a sort of three legged stool. The first leg is Trump’s supply eradicating foreign policy, the second is the arrangement between OPEC and Russia that fell apart on Friday March 6th, and maybe the most important leg is Wall Street stupidity.
Let’s talk about the stupidity first. I hate to sound like Donald Trump here, but Wall Street stupidity actually is something that can be blamed on China. Back in the 20th century,US oil investors used to understand the laws of supply and demand.
In the 1970s, when the Middle East first asserted its power over supply, prices spiked. But in the 1980s, prices crashed due to rich world efficiency drives and the identification of new petroleum resources all over the world. The 1990s saw a well balanced oil market. But then came the China era. As we all know, China’s rapid growth sucked in commodities from all over the world, and oil and gas producers were huge winners. Not even the 2008 financial crisis slowed things down for more than a year or two.
For 15 years from the late 1990s until 2014, a generation of Wall street investors were trained to believe that oil prices didn’t go anywhere other than up.
You have probably heard about the amazing success of the US oil industry. It’s true that this success is due to a range of ingenious new technologies, fracking, directional drilling, AI, whatever. But none of it would have been possible without the idiocy of a bunch of Wall street people who have forgotten the laws of supply and demand. Despite 6 years of evidence, some still seem to believe that a barrel of oil just naturally costs over 100 bucks. In the early years of the shale boom, from 2012-2014 this strategy worked, and prices stayed high as the US took more and more market share from other producers.
By 2014 Saudi Arabia had had enough, and they flooded the market in an attempt to kill the new US production. But Wall Street backed Texas up, because of that foolish faith in oil prices that a spurt in China growth had given them. Prices went even lower than they are today. By 2016 every oil producer was hurting.
Late 2016 is when the other two legs of the stool supporting the oil industry came in. Russia had never been a member of OPEC, the cartel of oil and gas producing countries. But in Late 2016 they joined with Saudi Arabia in the OPEC+ agreement that limited oil supplies. It was supposed to be for just six months, to balance the market. But continued low prices meant the agreement was extended for over three years.
2016 was also the year that Donald Trump came to power. As I pointed out in an earlier video, his presidency really has been “oil industry first”. His efforts have led to the crushing of the Venezuelan, Iranian, and Libyan oil supplies, and his absurd choice to heighten tensions in the Middle East has given the whole industry a hefty risk premium. After 2016, thanks to Russia, Saudi Arabia and Donald Trump, prices recovered somewhat, and in 2018, the United States became the world’s largest producer of oil.
What’s important to realize is how incredibly shaky all of this already was, even long before the Coronavirus. After 6 years, Wall Street was getting sick of waiting around for profits. Events like the September 2019 attack on A Saudi oil refinery showed that oil markets were too well supplied to get screwed up by Trump’s hyper-aggressive foreign policy. And most importantly, Russia and Saudi Arabia were real sick of cutting down their production so Texas could pump more.
On March 6th, under the influence of the Coronavirus driven plummet in demand, Russia refused to agree to new cuts in production, so Saudi Arabia decided to go to war. Price War. The Saudis have announced the end of OPEC production cuts, and have announced deep discounts to drive up their market share. Russia is also opening the taps.
As the US oil industry starts whining and begging for even more handouts, it’s important to emphasize what just happened here. Russia and Saudi Arabia just spent three years manipulating the price upwards, essentially creating a jobs program for US oil and gas companies. In the age of Coronavirus, this simply wasn’t viable any longer. The transportation infrastructure of China, Europe and the United States is now almost entirely shut down. Saudi Arabia and Russia have inaugurated an actual free market in oil for the first time in three years.
A lot of people seem to think that this fight will go the same way that it went in 2014, and that the Saudis will be forced to back down. I’m not so sure. Markets are dumb, and Wall Street is pretty stupid, but I don’t think they’re that stupid. After failing to make much money for six years, I think the Wall Street leg of the stool is probably gone. Keep in mind that 2014 was a relatively good time for investors, not the horror show we’ve seen unfolding over the past month. Trump is doing what he can, but buying some extra barrels for the strategic oil reserve isn’t going to make up for closing down most of worldwide air travel. Also, you may not have noticed, but the US and Iran are just as close to war in Iraq as they were in January. Nobody cares.
So I think it’s possible that Saudi Arabia could win this one. You all know that I think the Saudi regime will be gone by 2030, but I think MBS may have consolidated enough power to succeed where his predecessors failed in 2014. Last week he arrested most of the country’s remaining independent power centers. But what may be a 2020 victory, will set the country up for failure in the later 2020s, as I laid out in a video over a year ago, entitled, how the oil market dies…
“If something can’t go on forever, it won’t. After finding themselves back in 40 dollars a barrel territory, four years later, I think Wall Street will pull the plug. Oil companies” are actually going to be expected to show returns, and US production will plummet. Which will lead to… wait for it… a spike in oil prices….
For the past four years the usual exploration and development just hasn’t been happening. All sorts of exciting new oil locations have been found, but understandably, folks haven’t wanted to build out projects that need oil to cost 70 to 80 dollars a barrel to be viable. The world really has come to rely on that extra production from the United States. When wall street decides to end the party, I think a short term supply shortage is very possible.
I am talking about oil costing more than 100 dollars a barrel again. But only for a brief period of time. It’s not going to be shale that kills the rally the next time around. It’s something entirely different. Electric cars. After decades of being a bad joke, electric cars really are finally poised to take over.
Every large car maker seems to be coming out with new models next year. There is one massive problem though.. price. At current oil prices you don’t actually save any money by buying an electric vehicle. The other problems are technical ones like range and charging stations that will quickly be fixed by a mass market. But we won’t get a mass market if it’s cheaper to buy a gas guzzler. Electric cars are waiting on a big bang.
The post shale surge in oil prices will be the electric car big bang we have been waiting for. Once the mass electric car market starts, a fall in oil prices won’t actually matter. The volume of cars sold will drive innovation, and oil won’t be able to keep up. By the 2030s oil should cost around 20 dollars a barrel. And that is how the oil market dies. Or maybe not.”
It’s interesting to note that as of yesterday, West Texas Intermediate prices were already falling briefly into the 20s. The US oil industry won’t die completely, but it almost certainly won’t be the world’s biggest producer anymore this time next year. Saudi Arabia’s old model is about to have one last heyday. But it will be the last one. And it won’t last long.
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