Oil impacts directly or indirectly many of the businesses in our area of the country. We have watched an incredible boom in North Dakota that seemed it would continue into the foreseeable future, followed by a severe slide of prices down to a level to areas where the 55 gallon barrel the oil comes in, has more value than the oil inside it! We have also seen the number of drilling rigs fall and new exploration come to a halt as it is not economically feasible.
This blog is an attempt to show the various forces at play in the oil market today. As for the direction of oil prices, my stab at it is as much of a guess as anyone else.
Bloomberg Business reported that the largest oil producing country in the world in 2015 was….the United States! Second is Russia. When we think of oil we begin to focus on OPEC countries, who collectively produce the largest amount of oil. But one of the main reasons for the price drop has been the extra supply of oil produced right here in our own country. We produce more oil that we consume. Congress also reversed the ban on US oil exports recently.
The low price of oil by US companies was not felt as much in 2015 as most prices were hedged. This year, most of those hedges will expire, making companies more exposed to the market prices. Another issue with many US producers is the amount of leverage taken on by oil producers. Most of this was given when it seemed prices would stay in the $60 range or higher. Now, with prices half of that, we could see a rash of defaults and lender stress.
The low oil prices have devastated the economies and propelled sovereign debt higher in countries heavily dependent upon oil sales. Most OPEC nations are running large deficits and are not producing enough revenue from oil to satisfy all their government budget. So any attempt to bury the US frackers is also severely hurting oil dependent countries.
Saudi Arabia had a record budget deficit of $98B at the end of 2015. This is 15% of their entire GDP. The Saudi government slashed its 2016 budget by 14% and increased domestic fuel prices by 2/3, even though it is only around $0.20 per gallon. The Saudi sovereign wealth fund began to repatriate funds from oversees money managers. This has drained some liquidity from stock markets around the world.
Saudis are also issuing bonds for the first time since 2007 and plans another $32B in 2016. They also are selling parts of their crown jewel, Saudi Aramco, in an IPO. But all these acts will not dig it out of the oil price war. Bank of America expects that $30/barrel oil will shoot the Saudi budget deficit up to $180B.
Global oil supply numbers look to increase once Iranian sanctions are removed and it comes back into full sales and production. Of course, there is still severe tensions between Sunni and Shia, as there has been for over 1000 years. The recent warming of US-Iranian relations has also pushed the Saudis and other OPEC countries in the region to seek help from Russia, in order to reduce worldwide production. I would look for something to occur as neither OPEC nor Russia can afford the prices to stay down for an extended period of time.
On the demand side, worldwide economic growth has slowed and demand is down. There has been more of a push for other non-fossil fuel sources, which has left large supplies unused. Supply should also begin to stabilize as old wells experience lower production and there are not enough new wells to take their places.
One of the biggest events I expect to see is for the Saudis to break their riyal-dollar peg. Saudi Arabia has had their currency tied to the dollar since 1986. The 12 month forward contracts on the riyal-dollar rate are now trading at a 17 year high. The peg to the dollar has caused the Saudis to blow through their reserves. This sounds like the Chinese problem. China has devalued its Yuan against the dollar several times in the past few months. Saudi reserves have dropped by over $100B in the past year.
If the Saudis do not devalue their currency they will have to severely cut oil production to drive prices back up. If they do devalue, they will cause some global upset to stock markets just as the recent slowdown in China has as well. Khalid Alsweilem, the former head of asset management of the Saudi central bank, said that the dollar peg was the anchor of Saudi economic policy and global credibility for the past 30 years. A change will stir up turmoil within the kingdom.
I would expect the Saudis to devalue their currency and also some accord to be reached with Russia and Middle Eastern OPEC countries to find a way to decrease production. I also expect as some at Goldman Sachs have projected, that we will begin to see an increase in oil prices. I would expect some increase to be modest, with slowing growth in the US and stagnant growth around the world.
In the end, my opinion is just a guess. The only way I can be correct in my forecast is to say that prices will fluctuate!