OPEC Propaganda Scheme

Jim Brown
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Don't believe everything you read in the headlines. That is especially true if the source is OPEC or Saudi Arabia.

Last week OPEC said the price of oil will not return to $95 until 2040 or 25 years from now. It is hard enough to predict the price of oil a year from now much less 25 years from now. They also said they were not going to cut production until 2019.

This is pure propaganda designed to put fear in the minds of shale drillers and make them cut back even more on capex spending which will eventually lead to lower production. If OPEC can make the U.S. drillers believe they are going to have to live with the current prices until 2019 there will be a lot of them that stop drilling completely.

With WTI at $35 the price drillers in the Bakken receive is a lot lower. The recent discount was a whopping $8 below WTI prices. The discount is because of transportation costs and the ultra light nature of the Bakken oil that produces less value when refined.

Since the average cost of a barrel in the Bakken is well over $35 the current glut has slowed spending significantly. The Permian Basin in Texas is still progressing because they have pipelines to the Texas refiners and to Cushing Oklahoma which is the delivery point for crude futures contracts. Wells in the Permian are also cheaper to drill but profits, if any are extremely small at $35.

If OPEC can convince U.S. drillers they are going to continue this suicide by price then the long-term benefit to OPEC is higher prices for longer when they do rise because the shale drillers will be decimated by the time the prices rise.

Unfortunately there is a flaw in this plan. Saudi Arabia announced this week a $98 billion budget deficit in 2015. They had to sell debt to raise money for the first time in a very long time. The headline out today is that they are considering selling stakes in their various fields in order to raise cash.

Saudi Arabia receives 80% of its revenue from its oil sales. In July 2014 just before the oil crash began they were selling $1.2 billion in oil every day, 365 days a year. Today, with oil at $35 they are only receiving $385 million, a drop of -$770 million a day or a whopping $281 billion a year. This is truly financial suicide.

Other OPEC nations are in the same financial hardship. They all receive the bulk of their revenue from oil sales. They all have huge social programs to keep their citizens from rioting and demanding a change in government.

Saudi Arabia has assets held overseas from when times were good and oil money was flowing. They announced on Monday they were going to sell these assets to help fund the government in 2016. The other OPEC nations have nothing to sell but oil and most cannot pump any more than they are already pumping.

In a desperate move OPEC is trying to talk down future drilling plans with the headlines listed above about oil prices remaining low for a long time. Meanwhile the pressure is building against Saudi Arabia. Other OPEC nations are openly hostile and the cartel is fractured. They cannot do anything against Saudi because Saudi has the excess oil. Unless Saudi cuts production the glut will continue.

The IEA believes demand will increase by 1.2 mbpd in 2015. They also believe U.S. production will decline by a record -570,000 bpd to roughly 8.6 mbpd from the current 9.179 mbpd. That is already down from the peak earlier this year at 9.61 mbpd. Currently there is a 1.4 mbpd production surplus. Venezuela's oil minister warned again last week that this continued would become a catastrophe when the world's available storage capacity ran out. Oil at $30 could quickly become oil at $10 or $15 if there are no bidders because there is no capacity. The IEA contradicted this worry saying there was plenty of capacity to last until the end of 2016.

If the demand and production numbers work out like the IEA expects we should see the glut disappear by next summer and production balance with demand. That is a big IF and it will be months before we know how it will play out. Iran, Iraq and Libya are the wild cards with each claiming they are going to boost production significantly in 2016.

Don't believe everything you read in the headlines and especially if it comes from an OPEC source. At this point, it is a race to see who runs out of money first, Saudi Arabia or shale drillers.

U.S. oil production has already dropped sharply after the three year spike but despite a significant drop in capex spending it has leveled off at 9.179 mbpd. Can U.S. drillers out wait Saudi Arabia?

When crude prices roll over again in January as inventories begin to move higher we will see energy equities decline once again. Energy investors should be patient. Oil prices still have further to fall.

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Active Rigs

Active drilling rigs declined -9 to 700 for the week ended on Friday 12/25 and that is a 10 year low. Oil rigs fell -3 for the week to 538. Active gas rigs fell -6 to 162. Active rigs have now declined -1,231 since the high of 1,931 in September 2014. Active offshore rigs were unchanged at 24.

Oil Inventories Week Ended 12/11/15

Crude inventories declined -5.9 million barrels to 484.8 million.

Refinery utilization declined from 91.9% to 91.3%. That is up from the low of 86.0% on October 9th.

U.S. production rose +3,000 from 9.176 to 9.179 mbpd.

Cushing inventories rose from 60.1 million to 62.1 million and nearing a record high.

Gasoline inventories rose +1.1 million barrels to 220.5 million as refiners accelerated production of winter blended fuels.

Distillate inventories fell -0.7 million barrels to 151.3 million.

Details in the graphic are for the prior week. All numbers are not available until the Friday of the following week.

In the graphic below green represents a recent high and yellow a recent low. The blue-green represents a record high.