Why this oil crash could be 'different'... 'If you stop drilling... the music stops'... Saudi Arabia versus the United States... An update on 'Dr. Copper'... The latest on gold and silver...
This oil crash could be "different"...
Following the 60%-plus decline in oil prices over the past 14 months, we would expect to see oil production begin to decline.
But that hasn't been the case so far. Instead, oil production is still increasing.
Member countries of the Organization of the Petroleum Exporting Countries ("OPEC") have been pumping millions of barrels per day (bpd) more oil than their agreed-upon target.
At the same time, producers here in the U.S. – particularly shale oil drillers – are maintaining or increasing production as well.
And as we mentioned yesterday, there are reasons to believe we won't see oil production fall – and oil prices recover – for longer than many expect.
Regular readers know the latest crash was set off by the unprecedented shale oil boom here in the U.S. As Porter explained in the March 13 Digest...
What has happened over the last five years in the U.S. oil patch is the most important economic event since Bretton Woods monetary system failed in 1971 and the U.S. left the gold standard. And unlike the collapse of Bretton Woods, this economic revolution is good news for America, better than anyone can yet even imagine. But there's going to be a little turmoil first on the way to prosperity.
Since bottoming in 2008, U.S. oil production has almost doubled from 5 million barrels a day to more than 9 million barrels per day. That's nearly a doubling of production in just seven years. The last time the U.S. produced this much oil was the year I was born – 1972. And the "doubling date" prior to this peak was 1944. It took the U.S. oil industry almost 30 years to double production. But this time it only took seven years. And these numbers are a little misleading because they don't include other types of liquid hydrocarbons, demand for which has grown tremendously since the 1970s. When you put together all forms of liquid hydrocarbons, American supply is more like 14 million barrels per day – well over 100% more than we were producing seven years ago. How is this possible?
The simple answer is a little bit of technology and a whole lot of money. Spending on global oil production has increased by around 350% since the early 2000s. Back then, the global oil exploration and production industry was spending around $150 billion a year on capital investments. By 2013, that figure had grown to more than $500 billion a year. In the U.S. alone, the 50 largest oil and gas production companies in 2013 invested nearly $200 billion into new production. And guess what? Markets work. They found huge new supplies of oil and gas.
OPEC has historically decreased production during oil price declines.
Its 12 member countries produce about 40% of the world's crude oil and about 60% of the oil traded internationally, according to the U.S. Energy Information Administration. This has given them significant influence in the market, and has helped put a "floor" under price declines.
But booming production is shaking things up... U.S. oil production has soared, and OPEC sees it as a growing threat to its market share.
This time, OPEC did the opposite... and started an unusual game of "chicken" with the U.S. shale oil industry. From a recent article on financial-news website CNBC...
Natixis Lead Oil Market Analyst Abhishek Deshpande said that both [OPEC] and Western producers were working hard to maintain oil levels – simply as a matter of self-preservation. "They're left with no choice." Both OPEC and Western producers want to keep production high, but their motivations are different, said Deshpande.
OPEC is trying to preserve its market share and offset losses from low prices with an increase in sales, he told CNBC. However, Western producers are ramping up production to service a growing debt pile.
"They have taken large amounts of loans to drill rigs on a weekly basis or monthly basis – how do they pay back this money? The only way you can pay back this money is by keeping on drilling," Deshpande said. "If you stop drilling, basically the music stops."
In short, OPEC believed increasing production would push prices even lower (which it did) and put many of its Western competitors out of business.
But that plan has not gone as they hoped. From an article in British newspaper The Telegraph...
If the aim was to choke the U.S. shale industry, the Saudis have misjudged badly, just as they misjudged the growing shale threat at every stage for eight years.
"It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run," said the Saudi central bank in its latest stability report. "The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience," it said.
One Saudi expert was blunter. "The policy hasn't worked and it will never work," he said.
The crash in prices has decimated higher-cost producers – like those in the Canadian oil sands – and pushed "Big Oil" companies to delay billions of dollars in new projects.
But it hasn't had the same effect on the shale oil industry. More from the article...
The problem for the Saudis is that U.S. shale frackers are not high-cost. They are mostly mid-cost, and [experts] think shale companies may be able to shave those costs by 45% this year – and not only by switching tactically to high-yielding wells.
Advanced pad drilling techniques allow frackers to launch five or ten wells in different directions from the same site. Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. "We've driven down drilling costs by 50 [percent] and we can see another 30 [percent] ahead," said John Hess, head of the Hess Corporation.
It was the same story from Scott Sheffield, head of Pioneer Natural Resources. "We have just drilled an 18,000 ft. well in 16 days in the Permian Basin. Last year it took 30 days," he said.
The crash isn't hurting the shale industry as planned, but it is taking a toll on OPEC members...
The most influential member of OPEC – Saudi Arabia – produces nearly two times more oil per day as the next biggest OPEC member. As the article mentioned, it's the primary driver of this plan.
But it relies on oil for 90% of its economy... including the funding of the massive "welfare state" that helps keep the royal family in power.
According to the International Monetary Fund, Saudi Arabia needs oil prices to be at least $106 per barrel to balance its 2015 budget. At current prices, the country's budget deficit will grow to $140 billion this year – or 20% of gross domestic product.
With prices so low, the country has been burning through its international reserves. The Saudi Arabian Monetary Agency ("SAMA") – Saudi Arabia's central bank – currently has $672 billion in international reserves – down from a peak of $737 billion last August.
Reserves are currently being depleted at $12 billion a month – a rate that would exhaust these funds within five years. And the Saudis are clearly getting worried... SAMA recently began issuing bonds in an attempt to raise $27 billion by the end of the year.
But Saudi Arabia isn't the only OPEC member with problems...
Several other members – including Algeria, Libya, Nigeria, and Venezuela – require even higher oil prices to balance their budgets. Most of these countries are already economic disasters.
So Saudi Arabia and OPEC find themselves in a difficult position...
They need higher prices for long-term survival, but they need to keep producing oil today to help offset the loss of revenue from lower prices. More important, it's unlikely that OPEC could simply slow production and solve the problem anyway...
The low cost and high efficiency of the shale producers mean any bump in oil prices is likely to increase production further. And that's exactly what we're seeing today...
According to an article this week on financial-news site MarketWatch, U.S. "rig count" – the number of oil rigs currently in use – is heading higher again...
The number of rigs drilling for crude oil has ticked up in recent weeks, ending months of steep declines, just as oil futures took another hit.
What gives?
"The recent increase in rig counts is due to prices two months ago. There's always a lag between price changes and drilling activity," explained James Williams, economist at WTRG Economics in London, Ark.
In other words, the rig count is moving higher in response to the increase in prices earlier this year. If OPEC acts to support prices, it's likely the same thing will happen again.
But the news isn't great for many shale oil producers, either...
As we mentioned earlier, a huge number of drillers have taken on enormous debts over the past few years, and many of them are unlikely to survive.
We'll finish up with a closer look at the U.S. shale industry – and what investors need to know – in tomorrow's Digest.
Meanwhile, one of the world's leading economic indicators just hit a fresh six-year low...
Copper is an industrial metal found in everything from cars and houses to plumbing and cell phones. Stansberry Research's resident resource expert Matt Badiali explained its function in the world's economy in the July 31 Growth Stock Wire...
In times of strong economic growth, the demand for consumer goods and building materials that include copper increases... and copper prices rise. In times of slowing economic growth, the demand for these things decreases... and copper prices fall. That's what we've seen over the past few years.
China consumes around 45% of the world's copper, according to the Wall Street Journal. Regular Digest readers know we've been keeping a close eye on China's economy and its stock market lately, which have been extremely volatile recently. As Matt wrote...
China is a major player in the commodities sector. It's the world's largest importer of raw materials like copper. So when its demand for these materials picks up, it's bullish for the commodities sector. For example, China's emergence as a major economic power helped drive the big bull market in commodities from 2002 to 2008.
Likewise, if the Chinese economy stalls – and many people think it has – its commodity consumption could sink.
But as Matt noted, China's economic growth is expected to come in at nearly 7% this year, almost three times the growth rate of the U.S. and nearly five times more than the eurozone. So demand from China should at least "hold steady."
More important, Matt says copper supplies are falling...
Many mines have been shut down because of low metals prices. And few new mines are being built. That means copper supply is falling. Steady demand and falling supply will lead to a massive surge in price in a year or two.
Still, that hasn't prevented copper prices from falling... Yesterday, the metal fell to a new six-year low. It's now down nearly 20% in the last three months alone.
And if China's central bank, the People's Bank of China, continues to devalue its currency (the "yuan"), commodities traded in U.S. dollars – like copper – will continue to be more expensive for China.
Elsewhere in the metals markets, silver prices had their largest fall in six weeks yesterday. Silver fell nearly 3% to close at $14.84 an ounce... but prices still remain above the recent multi-year low of $14.64 made earlier this month.
The news has been better for gold. It also hit a five-year low in early August at $1,085 an ounce, but prices actually rose yesterday while other commodities fell. Gold is trading for more than $1,125 today – a 4% rise in the last couple weeks.
That has been great news for gold stocks. The Market Vectors Gold Miners Fund (GDX) is up 14% since August 6.
Longtime readers know the key to making money in the resource markets is to buy near the bottom of the "boom and bust" cycle. And there's no denying we've had a "bust" over the past few years...
The prices of most commodities are down 50%... 75%... or more. Many resource stocks – particularly junior resource stocks – are down even more. At the same time, sentiment toward most areas of the resource market is terrible.
No one can consistently call the bottom in a market. Prices could head lower still. But these are the signs that accompany a significant bottom in the resource markets.
As we've discussed, we believe the price of many resources will be much higher several years from now. And investors who slowly build positions in the best resource stocks now could make an absolute fortune over the next few years.
If you're interested in being one of them, Porter mentioned a great place to start your research in last Friday's Digest...
Last month, the "best of the best" of the resource world met at the Sprott-Stansberry Vancouver Natural Resource Symposium to discuss their top ideas. We heard from resource experts like Rick Rule, CEO of Sprott U.S. Holdings... famed speculator Doug Casey... Franco-Nevada CEO David Harquail... plus Stansberry Research editors Steve Sjuggerud, Dan Ferris, and Matt Badiali, and a dozen other independent resource experts.
Now, we've arranged a way for you to get an online-access pass for just $249 to watch Dan's and Steve's presentations, plus many of the natural resource experts we hosted in Vancouver. Your pass includes audio recordings as well as the speakers' PowerPoint presentations. Learn how right here.
New 52-week highs (as of 8/18/15): Expeditors International of Washington (EXPD), UBS ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN (HOML), iShares U.S. Home Construction Fund (ITB), McDonald's (MCD), Constellation Brands (STZ), short position in Viacom (VIAB), and SPDR S&P Homebuilders Fund (XHB).
In the mailbag, Doc Eifrig addresses a subscriber's question about annual returns from selling puts. Send your questions and comments to feedback@stansberryresearch.com.
"What isn't being said and is only partially alluded to in the sales pitch is the amount of cash (or liquid assets) that you have to have in your account before you are allowed to sell a put option. For the Apple example at $125/share, that equates to $12,500, so the $400 received is like interest on your cash. Using a 60 day turnaround means you could do the exercise six times a year for a total of $2400 or 19% return on your cash. Not a bad return by any means, but the sales presentation makes is seem more 'free' than that.
"Claims of $35,000 of income per year are given, meaning that $180,000 of liquid assets would have to be held as collateral to generate that volume of income. Having to make good on a put option (on a blue chip stock) would probably mean a falling market overall and if you didn't have the ready cash to cover, then some of your choice holdings would be liquidated to cover in that same falling market. Or did I miss something?" – Paid-up subscriber Harold Lunt
Doc Eifrig comment: I'd argue that a 19% return on your cash is much better than "not bad." (Heck, consider what you'd make on that cash with it sitting in a regular savings account.) That's the kind of return that really grows your wealth over time.
And you're right – selling puts does take a decent amount of capital to get started. Of course, you don't have to execute a position with a cash requirement of $12,500 like the example you listed above. For instance, selling a put on tech giant Intel right now would require less than $3,000. Plus, we recommend that readers have $20,000 in their brokerage account to use our strategy.
It goes without saying that the more capital you can put up, the more money you can earn... and the more you have at risk. What you can dedicate to any investment is a personal decision, though we try to offer plenty of education on sound financial decisions through my newsletters.
Regards,
Justin Brill
Baltimore, Maryland
August 19, 2015
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