Why oil is crashing again... The 'game' continues... Is OPEC winning?... Why further declines could be coming...
Today, West Texas Intermediate crude oil – the U.S. benchmark – dropped to less than $40 per barrel for the first time since August. It's now down more than 20% from its recent October highs.
Longtime Stansberry Research readers know Porter was among the first analysts to predict the huge boom in U.S. oil production.
He was also the first to predict that it would lead to the historic crash in oil prices we've seen over the past 18 months.
He shared his latest thoughts on the situation in last Friday's Digest...
I bet a lot of subscribers thought I was completely full of B.S. when I wrote a few months ago that the "Peak Oil" nutjobs almost got it right. They just forgot a word. Instead of worrying about running out of oil, they should have been worried about running out of oil storage.
Well, I was right on the money. Despite huge cutbacks to drilling in the U.S., the Saudis and other OPEC members keep pumping as much oil as they can in a desperate bid to maintain their market share in the U.S. Land-based storage is nearly at capacity globally and now, according to the Financial Times, we're even running out of ocean-based storage (boats). This sets the stage for a truly epic bottom in the price of oil... and in gasoline prices, too.
Sure, it's great to have "nailed" such a big macro call on oil. I've been writing about how Peak Oil was nothing but clap-trap since at least 2006, when I could see that natural gas production was soaring and was going to boom. Likewise, we've been writing about the U.S. oil production boom since 2010 and we've been predicting big trouble for oil prices since 2011.
I was the first analyst anywhere to predict oil prices around $40 a barrel. But let me tell you, I wish I was wrong. Commodity price busts are painful, and tremendous damage is coming to our economy.
Like Porter said, despite the big drop in prices, Saudi Arabia and other Organization of the Petroleum Exporting Countries ("OPEC") members continue to pump huge amounts of oil.
As we've discussed, this is because they're locked in a dangerous game of "chicken" with U.S. shale-oil producers. Unlike in the past, OPEC responded to the flood of new oil from the U.S. not by cutting production (which has previously helped create a "floor" in prices), but by increasing it further. This caused prices to crash.
In short, the Saudis were betting they could deal with super-low oil prices more easily than U.S. shale-oil producers. If they could keep prices low enough for long enough, a huge number of heavily indebted shale-oil companies would go under. Production would dry up in the U.S., and OPEC would be free to drop production – and push prices back up – without losing its share of the U.S. market.
After nearly a year of low prices, the gamble may finally be starting to pay off.
In an article last month titled, "OPEC Is About to Crush the U.S. Oil Boom," Bloomberg reported that the Saudis are "finally on the cusp of choking off growth" in U.S. production.
But before you get too bullish on oil prices – or think this story is over – there are a few things you should know...
First, despite the slowdown, U.S. oil production is still relatively high. As of last month, production was still higher than it was when OPEC started this strategy last year. From the article (emphasis added)...
The nation's production is almost back down to the level pumped in November 2014, when the Organization of Petroleum Exporting Countries switched its strategy to focus on battering competitors and reclaiming market share...
While cratering prices and historic cutbacks in drilling have taken their toll on the U.S., OPEC members have also paid a heavy price. A year of plunging government revenues, growing budget deficits, and slumping currencies has left several members grappling with severe economic problems. The fact that the U.S. oil boom kept going for about six months after the group's November decision also means OPEC has so far succeeded only in bringing the market back to where it started.
"It's taken a hell of a long time and it will continue to take a long time – U.S. oil production has been more resilient than people thought," said Mike Wittner, head of oil markets research at Societe Generale SA in London.
In other words, it has been a much longer and tougher fight than the Saudis likely expected. And while they may ultimately win, the latest data suggest the fight could go on a while longer...
Earlier this week, news service Reuters reported that U.S. producers have just been given an unexpected "credit lifeline."
The fall round of "redeterminations" – the twice-yearly review periods when banks adjust their loans to energy companies based on oil prices and company reserves – wasn't as bad as expected.
According to Reuters, banks reduced total loans to oil and gas companies by only 4%, versus expectations of 15% or more. Some companies actually received increases. The article noted that cuts were smaller than expected because banks were "encouraged" by producers' ability to cut costs and increases in production.
Low prices mean oil revenues have plummeted. Producers – particularly small producers – are more dependent than ever on loans as a source of capital. Without them, many producers wouldn't last long.
A number of analysts (and likely OPEC) expected significant cuts during this fall's redeterminations to be the "nail in the coffin" for many of these producers.
Instead, this "lifeline" means many struggling producers may be able to "keep the lights on" – and keep pumping oil – longer than expected... meaning prices could stay low for longer than expected. From the article...
"If credit lines stay strong, companies will keep drilling and keep inventories higher and oil lower," said Chris Metcalfe, director of finance and investor relations at Gran Tierra Energy Inc., a small conventional oil producer...
"You won't see as much of a drawdown in capital expenditure as if there was a 15-20 percent drop in borrowing bases," said Nicholas Bobrowski, chief financial officer at EV Energy Partners, a U.S. oil and gas producer whose credit lines rose by $125 million to $625 million this fall...
"It makes for oil to stay at low levels," said [Thomas Rinaldi, institutional investor service director at global energy consultancy Wood Mackenzie]. "The companies aren't flush, but they aren't starving."
If oil prices stay low, the next round of redeterminations in the spring could finally bring significant cuts in energy-company loans.
But until then, don't be surprised if this game of chicken continues... and oil prices fall even further.
New 52-week highs (as of 11/17/15): Lancashire Holdings (LRE.L) and Constellation Brands (STZ).
Porter responds to one subscriber's questions about bonds in today's mailbag, and another subscriber sends in his gratitude for his investment education. What questions do you want us to answer? Send them to feedback@stansberryresearch.com.
"My two cents is usually worth just about that, but for the record: I have been reading your newsletters for about 8 months. Before I started reading I knew zero about investing. Now I know a little because of your newsletter and a few others. Maybe I'm dumber than the average rock, but after all my reading I realize just how much there is to know and how little I know. Others seem to think that they don't need your input or ideas – more power to them, I wish them the best of luck and it doesn't seem that luck carries you very far in investing.
"If you don't know, and you are smart enough to know that you don't know, you need to find someone you trust to guide you. I feel that you are that source. When my ship comes in I will be a customer in your Credit Opportunities service. Thanks for the information." – Paid-up subscriber Max A.
"Bought the new Bond program for $4500. Excited about starting but told by OX that they cannot enter limit orders for bonds. I sent a message to Stansberry and suggested that if I couldn't work the system I would have to cancel. Naturally, I had hoped for some help in working through the problem and the only response I received was that I couldn't cancel on the Internet but needed to call. I don't want to cancel but if this is the only help you offer perhaps I need to cancel the many programs I employ with Stansberry. I have been a long-time subscriber and had hope for better service.
"I am in Thailand and difficult to do much in the area where I am staying as wifi is spotty. If the only assistance you can offer is how to cancel and not how to make trades I need to know so that I can move forward one way of the other. This is my 3rd request for help since Friday." – Paid-up subscriber James Ford
Porter comment: James, I spent a lot of time – five days – writing long essays about how buying bonds is different from buying stocks. I also stressed that having a good broker is key and that you might have to talk to several brokers before you find the right one for you.
I don't know what OX is... But I do know that our subscribers have reported to me that Interactive Brokers' online platform is easy to use. We can't tell you how to buy these bonds – that's your broker's job. And I can't tell you which broker to use because I don't know anything about Thai brokerage firms. I'm not sure what more I can do for you.
Regards,
Justin Brill
Baltimore, Maryland
November 18, 2015
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