Here’s What’s Going on With Oil

Last week, I told you investors betting on higher oil prices right now might be in for a nasty surprise.

Despite low oil prices, U.S. production hasn’t slowed down. It’s at its highest level since 1973. With oil-services companies making it cheaper for oil producers to drill, U.S. production is unlikely to go down rapidly.

And the U.S. isn’t the only country not cutting back production…

As regular Growth Stock Wire readers know, oil prices have collapsed since June 2014. The benchmark West Texas Intermediate (WTI) crude price has fallen around 54%.

[ad#Google Adsense 336×280-IA]It’s down around $50 per barrel right now – making it impossible for most oil producers to earn profits.

In a perfect market, the low oil price would force oil companies to cut back production… and lower supply would eventually cause prices to rise.

But oil is far from a perfect market…

When oil prices have fallen dramatically in the past, some oil producers have increased production.

Take 2009, for example.

From 2008 to 2009, the average price of WTI crude oil fell 40%, from $102 per barrel to $61 per barrel. You would expect that would have sent production around the world falling… but it didn’t. North American oil production rose 2% from 2008 to 2009.

And it wasn’t just North America… many other oil-producing countries ramped up production, too.

Russia increased production by 174,000 barrels per day from 2008 to 2009. Brazil’s production rose by 130,000 barrels per day. Iran, Iraq, and Venezuela also increased production.

You see, Russia, Brazil, Iran, Iraq, and Venezuela have national oil companies. The oil revenue supplies the government with the money it needs to run. And if you know anything about government, you know it has a hard time spending less money. If oil prices fall, the government doesn’t care. It simply wants the oil company to sell enough oil to make up the difference… so production goes up.

But while these countries were increasing production, Saudi Arabia cut its production by 1.1 million barrels per day to help oil prices recover.

Saudi Arabia’s cuts (with help from the United Arab Emirates, Kuwait, and Libya) made sure the world’s oil supply fell by a total of 771,000 barrels per day in 2009. That was enough to send oil prices soaring from $61 per barrel in 2009 to $80 per barrel by 2010.

This time around is different though…

Once again, many countries are increasing oil production. The U.S. Energy Information Administration (EIA) says worldwide crude oil production is expected to exceed demand by 900,000 barrels of oil per day during the first half of this year.

And Saudi Arabia and the Organization of the Petroleum Exporting Countries (OPEC) have decided not to force production cuts. Instead, they’re going to let production fall naturally.

You see, the average price of Brent Crude (the world’s benchmark) from 2010 to 2014 was $102 per barrel. That’s a 43% increase from 2007. At that price, expensive oil all over the world became economic – miles deep under the ocean, under the frozen seas of the arctic, and even trapped in shale rock. Companies could afford to spend money figuring out the science to extract it, because the economics were fantastic.

Thanks to the sustained high oil prices, a gush of new, costly oil came on the market. But the world’s economies didn’t need it. This sent oil prices plummeting… and gave Saudi Arabia an opportunity. It could choose to prop up oil prices… or it could let them fall.

Letting the oil price fall is OPEC’s way of “trimming the bushes,” so to speak. Saudi Arabia is using low prices to prune back the expensive oil projects. Companies can’t produce the high-cost oil for long before they go bankrupt or shut down the project.

Saudi Arabia and OPEC are taking a long-term view of oil. By cutting off these projects now, it will cut supply… eventually. That will bring oil prices up… eventually.

But with global oil supply unlikely to fall in the short term and no increase in global demand, oil prices could easily trade in the $45 per barrel to $55 per barrel price range for the rest of this year.

Good investing,

Matt Badiali

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Source: Growth Stock Wire