As OPEC prepares to meet in Algiers later this month, crude oil producers face a supply glut and questionable demand along with a strong dollar and continued low prices. This week's price slump added to the uncertainty about long-term production, but gives short-term traders lots of opportunities.
By Vikram Rangala
Thursday, September 1, 2016
Saudi Arabia continues its policy, now over a year old, of producing crude oil at near record levels in order to maintain market share. After oil prices peaked in mid-2014, the Saudis and Russians opened the spigots to compete against the large flow of shale oil from North America. To some extent, the tactic succeeded, with some US shale producers struggling to repay debts and stay in business.
That plentiful supply was a major factor in keeping oil prices under $40 barrel for much of the last year and a half. This hurt producers with higher production costs. US shale oil, for example, costs over $50 a barrel to extract, in most cases more like $60. When oil was over $100 a barrel, shale was profitable. But with prices below production costs for over a year now, shale producers face a bleak outlook.
Saudi Arabia's cost of production, by contrast, is less than $20 a barrel. So not only are the Saudis squeezing out their competition, they're still turning a profit, albeit not as large as it once was. The talks at the end of September are supposed to be an informal discussion on price stabilization. That's something poorer, higher-cost OPEC producers like Venezuela urgently want, since cheaper crude has hit them the hardest.
Perhaps in an effort to calm its OPEC partners, Saudi Arabia announced that it will not actively try to flood the market with oil, though Energy Minister Khalid Al-Falih said the kingdom will remain "flexible" in response to the large demand from China and India.
That demand from China is not just for its tremendous fuel needs as the world's largest energy consumer. China's record purchases this past year, which have helped keep oil prices up from their lows, have gone partly into its extensive secret network of strategic petroleum storage tanks. These tanks are located on islands in the Yangtze River delta and in caves near the Yellow Sea coast.
The Chinese government has not reported how much oil is already in these storage facilities or how much more it intends to buy and store. In 2009, it announced plans to stockpile 100 days of imports as a strategic petroleum reserve, By contrast, the US SPR, the world's largest, holds the equivalent of 71 days of imports, or about 38 days of consumption at 2013 levels.
Given that China produces far less oil and imports more, the true status of its stockpile remains a mystery, as does its potential to affect the market. We don't know how much China could potentially impact short-term oil prices by increasing or decreasing its imports.
Another mystery that grew in the past year is where the world will get oil from next. Oil exploration in 2015 revealed only a tenth as much new oil reserves as it has on average every year since 1960. So far this year, oil discoveries have been even lower. This sudden drop is largely due to drillers cutting their exploration budgets.
The reason they cut their exploration budgets? Low prices mean producers aren't as rich as they used to be.
So oil producing countries are draining existing supplies almost as fast as they can. At the same time, they aren't finding new supplies the way they have for the last 55 years. That suggests supply is eventually going to dry up. It's not certain that demand will remain high, however.
With solar energy now nearly as cheap per megawatt as oil energy, and less expensive electric cars like the Tesla Model 3 coming out, some of them self-driving, we may well see a situation where the supply of oil goes down at the same time demand does. What that means for oil-dependent economies in the Middle East or for volatile countries like Nigeria and Venezuela remains to be seen.
In the midst of all that uncertainty about the long-term future of crude oil in the global economy, the short-term effect has been volatility and an almost daily stream of trading opportunities. Those opportunities used to be only available to traders with deep pockets and an appetite for risk, mainly large funds or individuals who think nothing of taking a $25 million drawdown for the chance to make $60 million.
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