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Oil Prices: This Should Terrify Energy Bulls

If you’re an investor and love, love, love oil and gas, now is the time to decide which is more important: expected returns or inherent near-term risks?

Stress/ Illustration / Getty

Oil Prices Slide on Oil Production Increase

OPEC (read: Saudi Arabia, the Middle East’s “sugar daddy”) continues to snub the global economy as it smugly holds to its steadfast philosophy of seeking—nay, overreaching its share of a supersaturated oil market in the face of a weak oil economy. Crude oil prices fell sharply lower at the start of trading last Friday, near $40.00 per barrel, the lowest range since 2009. Since the cartel’s next meeting isn’t until June 2, 2016, chances are really good that oil prices will remain low for the first half of 2016, if not much, much longer.


OPEC Continues to Manipulate Global Oil Prices

You could say OPEC (the Organization of the Petroleum Exporting Countries) surprised global markets when it announced last Friday that it was not going to keep oil production at its current levels. Before the meeting, many speculated the cartel would discuss a production cut—maybe not follow through on one, but at least entertain the idea.

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Heck, the International Energy Agency (IEA), in its infinite wisdom, said before Friday’s meeting that it had faith in Saudi Arabia to make the right decision: “I wanted to say that looking at the past, Saudi Arabia has always behaved in a very responsible manner, ” said Fatih Birol, IEA executive director. (Source: “Saudi Arabia Will Make the Right Decision, ” MSNBC, December 3, 2015.)

We all know what the “right decision” refers to when it comes to global commerce: power and money. If you can’t have both, at least be on top.

But it gets worse. Birol added, “When there was a problem in the markets, Saudi Arabia was always there to comfort the market and they behaved like the central banker of the oil industry.” (Source: Ibid.)

Amen. Who wouldn’t put their trust in a banker to ensure a policy is put in place that benefits the global economy and world oil markets, especially one that has the keys to the vault and doesn’t know the price of a loaf of bread?

On one hand, OPEC decided not to maintain its current level of 30 million barrels of oil per day. On the other, it decided to raise output to 31.5 million barrels of oil per day. All OPEC did, I suppose, was decide to be honest on a peripheral level. (Source: “Oil Holds Losses as OPEC Opts to Maintain Production Levels, ” The Wall Street Journal, December 4, 2015.)

In September, OPEC produced 31.57 million barrels a day, a third of the global supply. In October, OPEC produced 31.64 and in November, it produced 32.12 million barrels.

If history is any indicator of future actions, chances are good that OPEC’s output is going to be greater than it claims, especially when you consider that Iran will start to come online soon, now that sanctions have been lifted.

When and how much crude oil will Iran pump out? Iran could, as soon as January, start to supply 500, 000 to 1, 000, 000 million barrels per day, which is roughly one percent of the world supply. One percent may not sound like much, but when the world is drowning in oil, it’s significant.


Did Cash-Strapped OPEC Have Any Choice?

Sadly, what did analysts expect when it came to OPEC? That it would actually cut production? Saudi Arabia clearly believes that its strategy is working. Maintaining its market share, despite plummeting prices, has resulted in many U.S. shale producers cutting production, cancelling projects, and shutting rigs.

On top of that, Saudi Arabia has enough profits from past oil production to cushion it for the time being. Who cares if other members of OPEC are, in their words, suffering and losing lots of money as long as Saudi Arabia is happy?

And lowering oil production would mean the last year of pain was for naught. Who wants to admit that?

Plus, there could be a lot of pain on the horizon. Thanks to slumping oil prices, Saudi Arabia had to delay payments to government contractors, as it fell into a deficit for the first time since 2009. But it’s going to get even worse. Saudi Arabia and other Middle Eastern oil producers face a combined $1.0-trillion budget shortfall over the next five years if crude oil prices remain near current levels and if economic reforms aren’t introduced soon. (Source: “Will fiscal pain of low oil prices force Saudi Arabia’s hand?Market Watch, November 10, 2015.)


Why Oil Bulls Are Wrong

For more than a year now, oil bulls have been telling us to buy the bottom. It’s what they do; albeit, not very well. In the face of a weak global economy and a world awash in oil, bulls continue to tempt us with tales of a near-term upswing in oil prices.

Their rationale: falling rig counts coupled with decreased shale production and drastic cuts in exploration will result in big declines in production, which will support oil prices. This makes sense if the U.S. oil industry exists as an island—but it doesn’t.

Further, according to an internal OPEC document, if current production remains unchanged, markets will be oversupplied by 700, 000 barrels of oil a day in 2016. But if OPEC did what it actually said it would do—that was to hold production to its agreed-upon level of 30 million barrels a day—markets would face an 800, 000-barrel deficit per day in 2016, forcing countries to access the large quantities of oil in storage. (Source: “OPEC Internal Report Warns Oil Prices to Remain Depressed, ” The Wall Street Journal, December 3, 2015.)

Admittedly, there is more long-term upside potential than downside risk when it comes to crude prices, but you can’t listen to the bulls when they wax eloquence about the rebound in oil prices in the second half of 2016. OPEC isn’t going to stop a program it thinks is working.

If you’re an investor and love, love, love oil and gas, now is the time to decide which is more important: expected returns or inherent near-term risks?

Courtesy of Profit Confidential, by John Whitefoot



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