Today's oil market is intriguing to us with so many moving parts and only a few players who can really call the shots. Let's see why prices are what they are and what the US can and will do about them.
Gas at the pump has backed off the last month from nearly $4 per gallon to now approaching $3 per gallon. Let's point out that just less than four years ago gas at the pump was selling for $1.80 or so. So even with the decrease in the last month we are still almost double 2008. Since oil per barrel was much higher then, $80 vs. $125 then, there must be some issues that are not pushing prices down even further. Simply put most are political, and not supply based.
The current drop in oil prices per barrel is being manipulated by the one player right now who can and will do something about it and that is Saudi Arabia. Contrary to anyone who writes or says otherwise they have a huge supply that can last for almost eternity. They also can produce oil out of the ground dirt cheap for best guess around $10 or $15 per barrel, maybe less. Best guess here is because the royal kingdom keeps their oil pool info and cost to produce held closely so as to be able to not be manipulated themselves. So even with oil at $80 per barrel Saudi Arabia can pump and dump and still makes lots of cash to keep it's citizens happy.
The Saudis started this extra pumping around a month ago in anticipation of the world oil embargo on Iranian crude taking hold July 1. No one knows if countries will actually adhere to the embargo, but the oil market concerned with the lower supply had already began pushing up barrel prices. Saudi production quickly put an end to that with added supply that showed up in storage in the US with a huge glut of oil. The Saudis are not friendly with Iran and want that regime gone and would like to see the embargo work. Therefore the added supply makes countries who would be getting oil from Iran less jumpy. The added supply also has the effect of keeping prices lower and hopefully keeping the world from going into a complete new recession. A recession could push barrel prices towards $60 or even $50 and even that is too low for the Saudis.
The other added incentive for the Saudis is to keep the US and Canada from expanding it's own production and with prices around $80 that keeps oil field developers here so close to cost to produce they do not go out a look for new supply. It also puts the hurt on Russia who has a higher cost to produce and has issues with prices being below $90 per barrel. Nothing like sticking it to the Russians who have aided Iran. Other OPEC producers such as Venezuela also have a higher cost to produce and are not real happy with the Saudis pushing down prices. But like I said Saudi Arabia is the big kid on the block and can do about darn well what it pleases.
The US and Canada continue to sit on large pools of oil. Canada has been developing theirs over the past decade and wants to sell it to the US via pipelines. Hence the political issues over building the Keystone XL pipeline which would provide over time enough oil to make the US totally independent for oil supply from US and Canadian sources. Here you got some strange bedfellows as environmental groups and big oil companies prefer less production to keep prices high which works for both interests. Big oil companies give generously to large environmental groups to not only buy goodwill, but also in hopes that regulations and caps will be put on oil resources. Talk about an unholy alliance but this surely is one.
Canadian oil production is increasing quickly and in three years will be 50% more than it is today. That oil is very heavy oil, which is nothing more than oil where the molecules are more numerous than what is known as light oil. Refineries on the Gulf Coast have been working on retrofitting to be prepared for heavier oil processing due to the expectation of lots of Canadian oil. Those refineries currently are using heavy Venezuelan oil. These refineries would like to switch to Canadian oil which is cheaper to transport over land via pipelines and frankly more reliable a provider than Venezuela or anybody else for that matter.
The only thing keeping oil prices high is government restriction of supply in the US. If the government would allow pipelines to be built and wells to be drilled we would find enough oil within 5 years to drop the price in half at the pump. The world is awash in oil and natural gas, enough to last almost forever contrary to anything you hear or read, but like any commodity supply, or restriction of supply, is either caused by political reasons or companies manipulating supply to raise prices. Add the restriction in supply, the fact that the huge refinery base now retrofitted in the US Gulf region is forced to buy high priced foreign oil, the worry about Iran and the result is double gas prices at the pump.
As we move forward it will be interesting to see if Saudi Arabia keeps up it's heavy pumping of oil past the embargo ending or more importantly past the US election when Obama will no longer show even the pretense of caring about Iran and it getting a bomb. If not, you can expect a significant increase in oil prices and gas at the pump next spring as the Saudis begin to use cash as an incentive to keep their people at bay from Iranian religious zealots. You can also expect that once Obama is freed of the concerns of re-election that the current pipeline projects will come to an end and oil supply restricted further putting even more pressure on gas prices as he would prefer to make green energy more attractive.
Longer term the most interesting point is that with all this natural gas and oil why are we wasting so much time and money even considering other energy sources. Contrary to all you read oil is not more polluting or messier than any other source of energy, it is just that some believe it to be almost evil in nature.
Believing that governments will continue to restrict supply and with stock prices down currently there are still good investments in oil. CVE and ERF in Canada are down in price and the former provides some income and nice capital gains potential, while the later is more focused on current income. XOM is a bellwether and it almost impossible to go wrong long term with the company that is maybe the smartest and most skilled operator out there. BP continues to be an interesting play with some nice current income and rebound in stock price possibilities. For those willing to consider higher risk higher reward scenarios OGZPY and LUKOY, both Russian producers offer intriguing opportunities with the consideration that Russian overlords sometimes do not consider shareholder interests like other countries. COSWF a Canadian producer which has had it's issues with getting production up full scale also is a interesting contrarian buy. Lastly for those who want to buy at the bottom, HGT, a US trust, has been beaten down badly and once natural gas prices begin to improve could make for some serious capital gains. The only question is when natural gas prices will rebound. Consider tax implications in Canadian stocks and US Trusts before you buy.
We currently hold ERF as a long and an option.
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