To quote the Financial Times of January 21: “Oil prices have dropped to less than $50 a barrel as weaker-than-expected oil demand in Asia has coincided with stagnation elsewhere, failing to absorb sustained output from OPEC countries and unrelenting U.S. supply — the main cause of a glut that is expected to get worse in the coming months.”
I added the emphasis because it says so much about what the media is getting so wrong about the oil patch these days.
Once a thought gets embedded in the media’s collective conscious, it takes on a life of its own, like a virus invading a host. Only, unlike a host that tries to fight off that virus, the media too often fail to fight back, accepting received wisdom without thinking that just maybe … it’s wrong.
And so today, I show you why the media is, if not wrong, then clearly telling you half-truths that give investors incorrect perceptions of the world around them. And I will show you why, because of that, you should be using cheap oil prices to load up on cheap oil stocks.
Debunking Asian Demand
We start with “weaker-than-expected oil demand in Asia.”
Logic tells you that that’s likely a load of ill-informed hokum, given the economic growth we all know is happening in Asia. And OPEC’s own data proves the point.
OPEC’s January report on the global oil market showed that Asia, as a whole, saw oil demand increase by 40,000 barrels a day, on average, across 2014. So much for the argument that oil demand was weaker than expected in Asia.
Now, Japan — what OPEC labels Asia Pacific — did see overall 2014 demand decline by 180,000 barrels a day … but even that’s half the story. Japan saw a significant drop in the second and third quarters that skewed the full-year results. In the fourth quarter, Japanese demand was racing higher with a 9% gain over the third quarter.
For the record, U.S. demand grew over the course of 2014, as did demand for every other region of the world, except Europe … and, again, even the Europe story isn’t what it appears. European consumption fell sharply in the first quarter of last year, just as it did in America, in part because of inclement weather. (Remember all those polar vortices and their impact on the U.S. economy? Well, they also impacted Europe.) But European consumption moved higher across the course of 2014.
Overall, 2014 oil demand globally grew by 1.06%, slightly faster than originally expected. And, to really hammer home the point that weak demand is not driving down oil prices, fourth-quarter global oil demand exceeded third-quarter demand by nearly one million barrels a day (and third-quarter demand exceeded the second quarter).
Shale’s High Price
Now, we get to “unrelenting U.S. supply.”
That’s true to a degree. Supply in the U.S. has certainly been problematic in that shale-oil producers are the reason supply slightly exceeds (still growing, not declining) demand. But … the unrelenting supply is actually on the cusp of relenting, potentially markedly.
This is a chart that Citi compiled to illustrate just how screwed U.S. shale producers are with oil in the $40 to $50 range, where we are now. Just about every single shale play in the country is a money loser below $50 a barrel.
Now, some wells will continue to pump for a while, losing money the entire time, because the production company simply needs the cash flow to service debt. But shale wells are notorious for their can-of-shaken-soda production profile — they spew out lots of oil very quickly when they’re tapped, and then they peter out to nothing in a year or two.
As wells begin to peter out, no producer will see any economic sense in spending oodles of money to produce oil for $60 to $80 a barrel when the price received is well below that. So, we’re going to see a tremendous amount of U.S. production dry up in coming months.
North Dakota, the epicenter of the shale boom, has already seen the number of producing oil rigs decline by 25%, and it’s seeing a vast number of layoffs in the oil patch — both very clear indications of a pending decline in production that will not quickly come back online, even as oil prices spike.
And that — an oil price spike — is the reason you want oil stocks in your portfolio.
Cheap Oil Creates Buying Opportunity
The world will face an oil-supply shortfall. Period.
Demand continues to rise, a fact underscored in data from OPEC, the U.S. Energy Information Administration and the International Energy Agency. Yet U.S. shale supply will begin to crumble, as will supply from a variety of oil wells all over the world that are losing vast sums of money at $40 and $50 oil. Those wells will shutter, too.
We face the reality that once bearish speculators are out of the oil market (and they’re the same ones who bullishly rode gold to $1,900 per ounce before abandoning the metal), we will see a snapback in oil prices that will cause oil stocks to rally sharply.
This is not an “if” … it’s a “when.”
Supply/demand economics assures it.
So, as the media beams over sub-$2 gasoline and the cheapest oil prices since the global financial crisis, use these moments of irrational stupidity to grab cheap oil stocks like Exxon Mobil, ConocoPhillips, Schlumberger, Marathon Oil and others.
Cheap oil is not fundamental to the current global economy (which is far healthier than the media makes you think). Cheap oil is a function of speculation at this point, not demand destruction as you’ve likely read elsewhere. As supply collapses, demand will once again command attention, and oil prices will rise — possibly quite sharply.
Those rising oil prices will bring oil stocks along for the ride. Get’em while they’re cheap.
Until next time, stay Sovereign…
Jeff D. Opdyke
Editor, Profit Seeker
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