Last week, Saudi Arabia proved that actions speak louder than words.
The Saudis cut the price of oil they sell to the world market… with no explanation at all.
As a result, oil prices fell below $90 last week, and investors were forced to helplessly watch their oil stocks fall.
Now, a move like this can only mean that the Saudi Kingdom feels threatened.
And unfortunately, the threat originates right here in the United States…
[ad#Google Adsense 336×280-IA]The Hidden Threat
If you have been a committed reader of Wall Street Daily, this move by the Saudis probably isn’t coming as a shock to you.
Last year, I wrote that Saudi Arabia is still a major factor when it comes to the price of the oil we consume.
You see, the Saudi royal family will do anything to maintain its grip on the Kingdom, as well as its own personal power, prestige, and wealth.
It’s well known that the Kingdom’s only source of revenue is oil, and it needs to sell as much as it takes to “make ends meet,” as well as put pressure on higher-cost competitors to drive down competition.
If that means selling oil at lower prices, so be it. The Kingdom has no other source of income and, thus, no other choice.
This contradicts the conventional belief that the oil king would cut production, but not cut prices, in an effort to keep prices stable or send them higher.
This was just a warning, though. The Saudis signal to the oil market is coming through loud and clear: They will sell oil regardless of falling prices.
And other OPEC members would follow suit, as most are in the same boat as Saudi Arabia. That is, they have no other source of revenue and possess leaders who are dependent on the largesse from oil sales.
But this roller coaster isn’t over yet. The news may get even worse as U.S. oil production ramps up in an effort to attain our energy independence.
You see, OPEC members are threatened by the huge supply surplus that may come out of the United States unless they can diminish the threat by forcing high-cost producers out of business.
If Saudi Arabia felt genuinely threatened, it could open the spigot and flood the market… literally.
Too Much of a Good Thing
WoodMac, an energy consultancy group, predicts that enhanced oil recovery (EOR) may boost production in the United States by up to three million more barrels per day in the next 10 to 15 years, as more manufacturing comes online.
Projects currently under consideration and development in places like the Permian Basin are using newer technology, such as horizontal drilling, to get more tight oil to the surface.
Already, oil from this region is being sold at lower prices than other regions. That’s because overproduction and lack of refinery capacity for the type of oil produced are becoming issues.
Ultimately, projections call for oil prices to fall as much as $30 per barrel if the trend continues unabated.
This could send the market into a tailspin…
Our Only Hope for Saving the Market
There are three saving graces in this situation.
First, crises in one or more major producers in the Middle East, like Iraq, may take excess production off the market.
Second, emerging markets would have to begin to grow at the rates they experienced in previous years to cause real upward chaos in the oil market. This is unlikely unless China’s economy begins to reflate.
The third and most promising solution involves opening U.S. exports of oil to world markets. American oil companies currently don’t export any significant oil to foreign countries. This results in less profits for producers, as they’re locked into lower domestic prices.
Of course, none of these situations would likely stem a price decline individually.
If not addressed, the outlook for prices based on the current no-export scenario will cause a major shakeout in the ranks of drillers that are operating with slimmer margins each day.
OPEC might be a vilified organization in the media and by American politicians, but it’s the one organization that has actually put dollars into the coffers of U.S. oil drillers by maintaining a supply/demand balance through the years.
The move by Saudi Arabia last week – along with continued increases in U.S. oil production – has changed the equation completely, and that should worry every investor who owns oil shares.
And “the chase” continues,
Karim Rahemtulla
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Source: Wall Street Daily