BY NOEL HARDY
Wednesday, January 21, 2015
“To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit”.
The production of oil is controlled primarily by a group of 12 countries collectively called the Organization of the Petroleum Exporting Countries (OPEC). The countries are Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela.
The group’s primary goals are stable prices, secure supply and sufficient investment. Stable prices let consumers and producers meet requirements; secure supply prevents disruption that can send prices spiralling and stall economic growth, and sufficient investment ensures that they will be able to provide the required oil to meet future needs.
The success of the group in meeting these goals has been brought into question in recent times as the price of Brent crude — the benchmark for oil prices — has fallen from US$115.00 per barrel in June 2014 to as low as US$43.00 in December 2014.
There is no doubt that OPEC is a prime example of an oligopoly. This is a market form within which the industry is dominated by a few players colluding to reduce competition that in turn makes prices higher for consumers. However, the recent downward spiralling of oil price begs the question as to whether OPEC still has the power to influence the price of oil collectively.
According to the Energy Information Administration (EIA), the analytical arm of the Department of Energy, United States oil production has moved from 5.0 million barrels per day in 2008 to 7.4 million in 2014. Oil production in 2015 is expected to average 8.5 million barrels per day and 9.3 million in 2016. An increase in the production of oil in the United States would make it less dependent on imported oil which would be a cause for concern to OPEC.
Update as of January 16, 2015 according to Bloomberg: “US drillers have taken a record number of oil rigs out of service in the past six weeks as OPEC sustains its production, sending prices below $50 a barrel. The oil rig count has fallen by 209 since Dec 5, the steepest six-week decline since Baker Hughes Inc (BHI) began tracking the data in July 1987. The count was down 55 this week to 1,366. Horizontal rigs used in US shale formations that account for virtually all of the nation’s oil production growth fell by 48, the biggest single-week drop.”
US producer prices in December recorded their biggest fall in more than three years on tumbling energy costs while underlying inflation pressures were tame, a cautionary note for the Federal Reserve as it ponders its next step on monetary policy.
Another cause for concern to OPEC is the resilient Russia who for years refused to become a member of OPEC despite its standing as the world’s largest oil-producing nation. Despite falling oil prices, Russia has been significantly producing more oil in an attempt to shore up incoming hard currency that has fallen off due to sanctions imposed by a United States-led embargo.
The economic slowdown in Europe and China which has seen a fall in the demand for the commodity is yet another cause for concern for OPEC.
The fall in demand for imported oil in the United States, Europe and China, albeit for separate reasons, has caused an oversupply of the commodity. Normally, the OPEC countries would have reduced the production of oil with the aim of reducing supply, as this is a natural move for oligopolies given the circumstances. OPEC members, however, could not come to an agreement to cut supply hence the freefall in its price.
We can all speculate about the price at which oil will stop falling, however, what is known is that if prices continue to fall, the ability of OPEC countries to remain viable will be determined by their cost of producing the commodity. If oil prices continue to fall, at some point in time it will become unprofitable to drill.
The cost of producing oil is not the same for all countries as according to a CNBC report supplied by Turner Mason Consulting firm, it costs between US$5 and US$10 to drill for oil in Saudi Arabia, between US$50 and US$100 in North America, less than US$30 in Venezuela, US$70 in Brazil US$20 to $40 in Nigeria and US$40 to $60 in Russia.
It is not anticipated that oil producing countries and, by extension, companies and their related firms will fall off the face of the Earth if oil prices continue to fall. There is obviously a bottom price.
What is also clear is that OPEC’s coming to an agreement will stabilise the price of oil, in turn fulfilling one of the group’s primary goals. Investors will need to make informed decisions as to which oil-related company to buy.
Oil-related companies are known for paying large dividends and this can act as a buffer to any short-term fall in the share price. Companies, however, can suspend dividend payments and this could impact one’s portfolio.
Diversification and risk assessment are critical in investing and must be borne in mind at all times.
View the original article here
Oil information for investors
