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After a hefty rise of 46.9% for the month through close last Friday, WTI (the U.S. crude oil benchmark) fell for two consecutive sessions to start this week.
As always, pundits with no real experience in the industry will blame the "glut" – as if this really explains anything.
Remember, in the summer of 2014, we had a greater surplus of crude at Cushing, Oklahoma – where WTI is set – than we do now.
And WTI was trading above $100 a barrel.
Clearly, excess supply on its own is not responsible for today's oil conundrum.
Instead, the key factor in how people regard the market and anticipate oil prices today is guaranteed excess supply.
And the actions of a single country will now decide whether that guarantee will remain…
U.S. Shale Oil Guarantees Excess Supply
Here's what's throwing the traditional supply and demand balance out of whack. The market now knows there are significant volumes of extractable unconventional (shale and tight) oil in America that could be brought to market in short order.
Whether that volume will be brought up is, of course, largely a function of demand and price. The former is rising globally but hardly at either the level or the rate of known reserves. Price, therefore, becomes the key factor.
At $60 a barrel, most U.S. unconventional oil can be produced at a marginal average profit. But that's not the case at $40 a barrel, or even $50 a barrel.
Keeping oil prices low enough that this American oil stays in the ground remains one of the bulwarks of OPEC's policy of defending market share.
But this has come at a hefty cost. All OPEC producers are running significant and expanding budget deficits. Those budget deficits are intensified by declining export revenue and made even worse by the need to import just about everything else.
After all, these are not diversified economies: everything you might want (other than petrochemicals) must be imported for hard currency.
This situation is made worse by the way Middle Eastern OPEC members avoided the worst aftermaths of the so-called "Arab Spring." In short, they bought their way out by expanding social programs and domestic spending.
Today, no OPEC nation has that luxury anymore, just as what I have termed "Arab Spring II" approaches. Even Saudi Arabia is cutting spending and increasing taxes.
Some OPEC economies – Venezuela, Libya, and Nigeria being the worst – are either careening headlong into crisis or are already basket cases.
The key thing to recognize – and which was strongly emphasized by discussions at the recent Windsor Castle energy meeting – is that OPEC members have been increasing exports, selling additional oil into an already saturated market, for two reasons.
First, despite depressing the price, additional sales remain the only way that these countries can acquire essential revenue.
Second, OPEC has acknowledged that there is no longer any reason to keep their oil in the ground.
This second point is dramatic. If oil were at a higher price (say, north of $60 a barrel), the strategy of keeping reserves in the ground would make more sense. Think of it as a commodity savings account.
But right now, the only thing accomplished by not pumping oil is allowing others to take up market share. So, OPEC nations end up in the unenviable cycle of shooting themselves in the foot to retain share of a market in which profits are declining – because of their own actions.
This brings us to the cancelled late-March meeting between OPEC and Russia…
A Production "Freeze" Would Stabilize Oil Prices
Recently, rumors suggested that OPEC and Russia would reach an accord on capping oil production in a meeting in Moscow before the end of March. Now, no production cuts were ever anticipated – just a cap on production.
After all, as those of us who remember how these things have played out in the past know, the Kremlin has never agreed to an oil production cut and then kept its promise.
Now, OPEC may regard the U.S. shale patch as its main adversary in the fight over market share, but there is just no central way to control U.S. production, either through the government or through national oil companies.
But there is in Russia.
What OPEC needs is an agreement that includes commitments from the main non-OPEC oil sources. Moscow certainly fits that bill.
The production cap also has a ready-made focal point: By using January's production figures, the production limit put a cap on production at close to record-high levels.
In other words, nobody would really be giving away anything by agreeing to the deal – least of all leverage.
Even so, the deal would stabilize and increase prices, because oil traders would finally be able to see a ceiling to the volume brought to market. In other words, the deal to "freeze" oil production would effectively remove the guaranteed excess supply that has been pushing down prices for so long.
However, Iran has not agreed to the deal, for reasons of its own…
Iran Needs Western Technology – Fast
Tehran is only just coming off Western sanctions that have paralyzed its economy, denied essential investment in its oil and natural gas production, fields, and infrastructure, as well as decimated the country's banking sector.
Iran urgently needs more revenue from oil exports. As you can imagine, putting a cap on how much Iran can participate in a game it has long been denied the chance to play is not popular in the country.
No wonder Tehran is resisting a production "freeze."
On the other hand, going alone isn't acceptable either, as Iran has been experiencing huge problems in its main oil fields. Without access to Western technology, expertise, and funding, the country's oil sector will remain in shambles.
At many major oil fields, pressure is so low that the gas that usually comes up along with oil has been lost. Pipelines are rupturing on a regular basis, and petrochemicals produced in the country have an irritating habit of simply exploding.
In short, Iran needs access to outside help fast. For all the talk of the country increasing its exports by 500,000 barrels a day, that rate will take time to reach, and is not sustainable given the current state of affairs.
Here's what's likely to happen.
OPEC (read: Saudi Arabia, which calls the shots) will give Iran a modified pass here, granting it some exceptions to the general production deal, and Tehran will show up at the negotiating table sometime in April, just like everyone else.
That should help oil prices stabilize, and is yet another reason to conclude that the bottom in oil was hit earlier this year, when WTI closed at $26.55 a barrel.
P.S. Marina and I are once again catching a flight to London, where I'll be attending an energy session in the House of Lords – the upper chamber of Parliament. I expect some exciting developments from there.
What the World's Leading Energy Insiders Fear Most: There's a crisis brewing in America's oil fields that's not unlike the 2008 credit crunch. Soon, it's going to spread to the rest of the world. The fallout won't be pretty, but don't worry. You'll be prepared – and ready to play it for some gains…
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.