I thought about titling this Update “Oil, Oil everywhere and not a certainty in sight” but there is certainty to oil just not knowledge of the future price of oil.  Unless you have only watched re-run sitcoms or reality TV shows (oxy moronic to call them reality)  then you know there has been a lot of hoopla made over the recent drop in oil prices and the future of oil.   I began writing this piece on October 28th and to escape the Ebola coverage I actually turned on financial channels during the week leading up to October 28th; I realized why I don’t leave them on during trading hours.  I don’t know why I am still surprised at the myopic coverage of mainstream US news.  Last Friday morning (Nov 7th) NPR and BBC both reported of 32 Russian tanks and a heavy force of Russian troops were crossing into Ukraine and that the most intense fighting yet seen in the conflict was then taking place in the capital Donetsk.  Not a mention by the mainstream US news coverage that day.  There was no shortage of media personalities trying to speculate as to why the price of oil was up so much on Friday – almost none even mentioned the Russian tank incursion.  Now today the financial news channels are full of comments that the market is looking to open lower on Russian/Ukrainian situation – there are signs that you could call it an invasion.

The barrage of people pandering their guesses about oil prices disguised as advice with no discussion of the dynamics of geo-politics was amazing to me. Even worse many of those I heard were some of the same voices making so much noise during the oil bungee jump of 2007-2009 (link to the chart showing why I call it the oil bungee jump).  To give you a summary of the data from the US Energy Information Agency (EIA) the price of Brent Crude Oil (considered a global measure) went from roughly $60/barrel at the end of 2006 to more than $140/barrel in July 2008 (oil is king) down to $34/barrel by December of 2008 (oil is dead)  then back to $78/barrel by October 2009 (all hail oil).  Yet the price of oil here in the US shale oil such as the Illinois Basinwhich covers parts of Illinois, Indiana, Kentucky, Missouri, Ohio and Tennessee went from $83/barrel in December 2007 to $126/barrel by July 2008  down to $33/barrel in December 2008 back to $86/barrel by November 2009.  US shale oil prices per barrel were even more volatile than global prices.

The claims that we have a glut of oil and predictions for the demise of oil being proclaimed today remind me of similar claims in fall of 2006.  I don’t know if we will have a similar ride in prices as we did but we have the makings of it shaping up with the recent events in the oil space.  First you need to understand the role Saudi Arabia is playing in the current oil chess match.  I believe Saudi Arabia was pursuing 3 objectives in recent months when they announced it would not cut production in the face of the oil price declines which caused prices to decline lower to current levels.

  • First and foremost to me, I believe they are leveraging for the very important upcoming Nov 27th OPEC production meeting.  Unlike the historical pattern of most OPEC nations to cut production when oil prices drop significantly, Saudi Arabia, by not cutting production, has them holding most of the cards for the upcoming meeting.  I’m pretty sure that they have an agenda of certain conditions they are going to want form other OPEC members.  Possibly Iran more than most considering Iran and Saudi Arabia are in an all-out cold war not to mention has been the second largest producing member in OPEC with Saudi Arabia being the largest.  Iran is being severely hurt by lower oil prices added on top of current global sanctions.  A fact I’m sure Saudi Arabia is well aware of.
  • Second to me, I believe Saudi Arabia is price fishing.   Meaning, I think Saudi Arabia is also trying to discover at what price will the US significantly cut production.  Remember the US is now an increasing exporter of oil with no letup it sight.  Saudi Arabia is having to deal with a growing competition against the US for market share.
  • Third, this seems like a typical business squeeze by Saudi Arabia to me:  drop the price of your product lower than your competition can handle, acquire market share from weaker rivals, then raise prices with a  greater market share.  Some analysts believe that Russia and Iran may not be able to sell oil at much lower prices.  Remember that Russian sales of oil and gas fund more than half of Russia’s annual budget making their economy somewhat of a proxy on the price of oil.  Several published reports say that Russia’s 2014 budget was calculated with $93/barrel and 2015 is calculated on $95/barrel… quite a bit lower than today’s levels around $77/barrel.  I find it interesting that Russia stepped up its Ukrainian military support last week in the face of recent near bottom oil prices.  Thursday and Friday (Nov 6-7) we saw oil rebound quite a bit.  Maybe this was purely a technical bounce; maybe the fact that reports of 32 Russian tanks were entering Ukraine had something to do with it as well.

The current evolving events as well as market conditions remind me of the storm that hit oil prices during the 18 month bungee jump in oil prices mentioned above but the end shape is not clear at this point.  Only time and probably an upcoming OPEC meeting will tell, but I believe the Nov 27thOPEC meeting will give a lot more clarity to the outcome of oil prices in the near term.  You may be thinking that a further plunge in oil prices would be a good thing…. Not so fast, while it may be good for the months that savings from things like  the price at the pump and cheaper plane tickets give you, it most likely will lead to a higher price range later for oil.  You see if prices plunge, then you most likely can get a real shut down of drilling activity, loss of drilling players (company bankruptcies), equipment degradation from idling, etc. which then takes even more time to get back up and running.  And unless demand is decreased drastically and remains so, this oil drilling shut down can result in a large price spike.  We saw this clearly happen from the 2008 oil price plunge settling up to a new $80/barrel average from the $60/barrel average prior.

From an investment standpoint, I believe it could be a wise time to buy partial positions in market share leaders in oil services and select drillers.  While many oil related companies and investments seem very attractively priced, I say only partial positions because first, the outcome of the Nov 2th OPEC meeting could result in lower oil prices still which could result in even better investment opportunity for the long term.  Many believe the line in the sand for a possible oil price plunge is $75/barrel.  The level to which it could plunge is unknown, though many still offer their speculations.   Regardless of what level, I believe a plunge in oil prices could set up an investment opportunity into oil related companies not seen since the market bottoms of 2008-2009.  If prices don’t break the $75/barrel level then this may be the time to invest.  In my own 401k I am changing my contributions to focus on natural resources for the time being to accumulate now and should prices drop further as I believe natural resources and innovation are the two most powerful investment themes for the long term.  Obviously this is not a strategy for everyone.  Each investor’s time horizon, patience for an investment, and risk tolerance differ by person.  As I wrote in my October 5, 2010 Market Update: Inflating Opportunities:

I have always advocated my long term (3+ years) excitement but offered a strategy of using strategic dollar cost averaging on weakness and reducing risk on peaks to weather the near term (less than 2 years) uncertainty. Please consider previous crisis moments when investors were warned “this time it’s different”:

  • Would you like to have invested in stocks and/or commodities in the early 1930’s when headlines warned the global depression threatened to end capitalism?
  • Would you like to have bought stocks and/or commodities in the mid 1970’s when headlines warned American prosperity was over?
  • Would you like to have bought stocks and/or commodities in 1990 when headlines warned the S&L crisis threatened the very financial well-being of America?
  • Would you like to have bought stocks and/or commodities anytime during the host of problems, scandals and tragedy from 2001 to 2002 when headlines warned investors might not trust investing again?

I believe we are living in one of the greatest periods of innovation and investor opportunities in history.  This is why I feel it is important to have buying power to add to holdings on sell-offs or panics in the markets.

Sometimes the market has sector sell offs rather than a broad based market panic.  Earlier this year we saw a significant sell off in “momentum/growth stocks” in April of this year and then a utility plunge in July of this year only to see many of both categories hit new highs months later.  Past performance is no guarantee of future results of course but if you’re looking for places to invest that are attractively valued and have already been beaten down, I believe the ‘oil patch’ could be an attractive place to look for both income and growth opportunities.

Please call us with any questions about your portfolio and/or situation as well as if you wish to discuss the ideas put forth in this update. As your advisor we work for you but it is still your money and I believe you should know what you own and why you own it. The ideas expressed in my Market Updates are simply my opinion. No one can accurately predict future events with consistency. My decision making is always first and foremost for your benefit; prudence and perspective govern my decision making.

*Periodic investment programs like dollar-cost averaging require continuous investment regardless of market trends. Investors should carefully consider whether they have the financial means to continue such investments during times of market declines.