Long term view of oil supply & demand

There is a lot of doom and gloom about oil prices in the financial media.  It is easy to find analysts who see no bottom in sight, and I have little to add to that view, except that I’ve seen for myself the fracking activity in West Texas.  Driving near sunset one can see for 100 miles (we identified a remote mountain feature at that distance), and there are 100’s of flares visible in the dusk.  Every few miles we saw an active fracking site with trucks rolling in and out.  The Saudis say they want to crush the frackers.  Is that really all that is going on?  These guys all around would make a lot more money if they’d cut production 10% and let the price double.  Who in the game is so stupid as to not do that?  Is it the American frackers?  They actually did cut some, as did the majors.  Saudi actually experienced a de facto cut over several years by losing market share.  Iran’s potential million barrels a day hasn’t hit yet, and will be a pittance when it does compared to a 40 million barrel a day market.  Roughly 10 million barrels each come from the U.S., Russia and Saudi Arabia.  Consider the following:

  1. Russia just took over from Saudi Arabia as the world’s top oil producer.  An article calls it the RED DAWN.  This means Russia is contributing more than Saudi Arabia to the excess supply!
  2. Earlier in the year it was speculated that the Saudis were trying to pressure Putin to withdraw support from Syria’s Assad.  Looks like Putin’s answer was just as aggressive as his military actions in Ukraine.
  3. These are temporary actions.  Russia is rebuilding its $300 million cash reserve, which it had begun to deplete to defend the ruble in its economic war with the U.S. resulting from the Ukraine sanctions.  Saudi Arabia has a $700 billion reserve.  These are large numbers, but not that large for countries that maintain a large military and keep peace in their borders with generous social programs.
  4. Saudi Arabia now faces the prospect that no matter how long it keeps prices low, whenever it allows them to rise, U.S. shale production will immediately rise.  Saudi Arabia will have problems in 2 years and face an “existential crisis” by the end of the decade.  The Russians will face one a lot sooner.  Putin’s term is up in 2018, and the next leader may value money over ego tricks.
  5. And finally the analysis that triggered my post … this video by Credit Suisse’s Jan Stuart ends with the observation that 4 million barrels capacity needs to be added each year to make up for production lost to wells that have ended their useful life.  At current prices, no one, including the Saudis or Russians, is making that kind of investment.  And demand is growing at a healthy pace.

Since this is more or less a poker game, each party trying to get the others to fold, all having deep pockets, a prediction as to when it will end is useless.  But as in any poker game, most players will eventually fold and it will end.  The advantage of shale, now that producers have got costs down, is that it can be turned on and off quicker than conventional production wells.  And the U.S. is not dependent on exporting oil.

I would not go out and buy oil based on this analysis.  But it encourages me to keep what I have and wait it out.


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