Why Is There an Oil Price War?

Over the last several months, OPEC representatives led by Saudi Arabia have been negotiating with Russia for an agreement to cut back on production from all oil and natural gas suppliers. The idea was that this would keep prices up even as global demand fell due to the coronavirus’s effects on the global economy and on China in particular. Russia never budged. In the end, Saudi Arabia refused to cut back its own production and rather decided to ramp up production while cutting prices in an attempt to cut into Russia’s share of the oil market. Neither nation is in a particularly strong economic position these days which makes the Russian foot-dragging and Saudi decision to cut prices an economic game of “chicken.”

How Can You Benefit from the Oil Price War?

As an investor, what can you do? Oil and natural gas companies with strong economic reserves will survive, making this a good time to buy for the long term. Getting out of companies with weak balance sheets, even at a loss, may be what you need to do to avoid further investing “bloodshed” as the virus, price war, and economic downturn play out.

Vox has a few useful ideas about companies benefiting from the coronavirus.

Predicting what people will do as more and more “lock downs” occur across the world or people simply avoid going out and mixing with crowds much as possible. Netflix stock has fallen a few percent, but the stock is trading at what it sold for a year ago and substantially above last fall. The point is that that when people stay at home they get bored and having entertainment will make time go faster. Netflix and similar streaming services may do OK.

Clorox is on a tear. It is trading at an all-time high as everyone is stocking up on cleansers in advance of the arrival of the virus in their area. Companies that sell soap and cleaners, like P&G, are good ideas. P&G has slipped a bit but is now trading at its price for last July.

Even Campbell’s is doing well as people stock up on food that will last (like canned soup) during a prolonged, enforced quarantine. Campbell Soup Company is off a few percent today as we write this, but it is up about 15% since a couple of months ago and more like 60% from last year!

Sitting on Cash and Buying Later

Last August we wrote about the silent warning for investors from Warren Buffett who was accumulating cash and not buying much. His rationale was that stocks were universally overpriced and nothing met his criteria for intrinsic stock value and other reasons for investing in stock.

If you have some cash on hand, it might be an excellent time to sit on it for now as you watch for opportunities in companies with good long term potential but which are being taken down in the current rush to sell.

In October of 2014, Saudi Arabia signaled that it was willing to let oil prices fall and no longer cut production to support higher prices. Since that time Saudi Arabia has spent nearly $50 billion of its foreign reserves to keep its domestic social contract going in the face of diminishing oil revenues.

The oil kingdom has put its money where its mouth is in an effort to protect market share and get both OPEC and non-OPEC members to limit oil production. So what has Saudi Arabia’s $50 billion bought? Saudi Arabia’s policy together with a flood of oil supply and slow global economic growth drove down the price of Brent crude oil from $115 a barrel in June 2014 to as low as about $45 a barrel in January. But the price of oil came roaring back in April, staging its biggest monthly gain in six years, and is now trading above $66 a barrel.

The low price of oil is hurting US producers more than the Saudis because Saudi Arabia spends a lot less to produce a barrel of oil than fracking operations in the Bakken formation of North Dakota. Oil producers such as Russia and Venezuela are begging for a production cut in order to drive prices back up. But decreased global demand coupled with the Saudis wanting to maintain their customer base make this unlikely. The wild card in this situation may be Saudi cash reserves and how far they are willing to spend down.

Saudi Arabia has some $708 billion of foreign oil reserves left to wage its oil war. The country’s new king, Salman bin Adbulaziz Al Saud, is dealing with a budget deficit of at least $40 billion this year – The Financial Times said it could reach $100 billion. Sub-$70 oil does not appear to be sustainable for Saudi Arabia, but for now it seems willing to keep spending its cash in an attempt to assert its will on global oil markets.

Iraq Production Recovers

As bad as things are in Iraq with the ISIS, Iraqi exports are up. Reuters reports that Iraq exports have hit a record high. This is another country that can produce a barrel of crude for substantially less than drillers in the USA.

Oil prices eased off 2015 highs on Friday after Iraq said its crude oil exports hit a record in April, and as the dollar strengthened.

Brent and U.S. crude rallied between 20 and 25 percent in April, helped by a weaker dollar and bets that a global supply glut would ease, following the June-to-January sell-off that halved prices from above $100 a barrel.

Friday’s pullback was sparked first by news that Iraq’s oil exports rose in April to a record 3.08 million barrels per day (bpd) from 2.98 million bpd in March, which served as a reminder of ample supply in the market.

OPEC supply in April rose to its highest in more than two years at 31.04 million bpd, according to a Reuters survey.

Saudi cash reserves may continue to fall if they insist on maintaining production quotas while more cheap oil from the likes of Iraq and Iran come on the market.

Lower Prices

The price of oil was inching up in April until Iraqi production peaked and global demand failed to strengthen. The Wall Street Journal notes how oil slips in price.

Oil prices retreated from 2015 highs Friday as traders assessed the recent strong rally and the still-oversupplied global crude market.

Light, sweet crude for June delivery recently traded down 78 cents, or 1.3%, to $58.85 a barrel on the New York Mercantile Exchange. Prices had soared 25% in April, settling Thursday at the highest price since Dec. 11.

Brent crude, the global benchmark, recently fell 64 cents, or 1%, to $66.14 a barrel on ICE Futures Europe. The contract had gained 21% in April.

Saudi cash reserves are likely to continue to fall if they insist on maintaining production to produce a global glut and in an effort to maintain their market share in light of weakening demand.

Saudi Cash Reserves and the Price of Oil PPT

Cash Flow from West to East

Think of it this way. China sells products to Europe and North America, and the rest of the world. China runs a big trade surplus. China spends its money on a big Russian Chinese energy agreement. China takes energy supplies away from Europe. In addition, the Russian Chinese energy agreement includes joint oil exploration efforts offshore from Russia.

Price, Always Price

According to press reports, all is not well with the Russian Chinese energy agreement. There are smaller nations across the globe where China can gain oil, natural gas, and other resources a bargain basement prices in return for loans and foreign aid. However, Russia still has a larger economy to sell energy products to, Europe. According to press releases the Russian Chinese energy agreement has been agreed upon in its general terms. But, price is still an issue and not all projects may come to completion as the old communist allies haggle over price like the capitalists that they have become.

Just Two BRICS out of Five

The shape of the world to come is changing. Brazil, Russia, India, China and South Africa are collectively known as the BRICS nations. They have strong and growing economies that are expected to eventually reach the level of both Europe and North America. Gone are the days when first the Europeans and then the Americans dictated terms for economic agreements across the globe. In both of our articles, Three Good Offshore Investment Ideas and Investing in Foreign Stocks, we noted the opportunities of investing offshore. The new Russian Chinese energy agreement is only one example of economic activity and investment opportunity outside of North America. The fundamental issue in investing in these situations is learning and understanding the fundamentals. Because many investors do not speak Russian or Chinese, it is often more efficient and profitable to invest in Western companies that do business in these regions of the world or to invest in foreign stocks listed as American Depository Receipts on US stock exchanges. Such investments can be directly related to big news issues such as the Russian Chinese energy agreements or more often related to the rise of a significant middle class in China, Russia, India, Brazil, and South Africa.

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Because of the return of Mr. Putin and because the world economy is ever so slowly improving after the worst recession in three quarters of a century let’s say that it is time to invest in Russia. What does Mr. Putin’s call for a new economy mean? Revamping old state run industries may make things run more efficiently but this has little to do with private investors.

Russia is the second biggest producer of oil in the world at just over 10 million barrels a day as of 2010. The nation’s economy consumes 2.2 million barrels a day and exports 5 million barrels a day. Its proven reserves are around 69 billion barrels. It is the world’s second greatest natural gas producer as well at 588 billion cubic meters a year. It uses 414 billion cubic meters of gas a year and exports 200 billion cubic meters making it the world’s leading natural gas exporter. Its reserves are estimated at 45 trillion cubic meters as of 2011 giving it first place in the world. But, if it is time to invest in Russia is it time to invest in oil companies in Russia? Mr. Putin, in fact, is trying to decrease the dependence of Russia on oil and gas exports. On a profitable investment timeline it may be time to get out of Russian oil stocks and not in as European threatens to fall into recession again and drive oil prices down.

The goal is to improve the business climate in order to attract more investment. This includes decreasing the still heavy hand of the state. Mr. Putin’s orders are to produce 25 million high paying jobs by 2020. Sounds like more of the commissars Mr. P. However, the goal of producing more high tech products is not just a pipe dream. Russia has skilled scientists and technicians. They, after all, are the link to the International Space Station now that the fleet of Space Shuttles have been retired.

The complete range of Russian industry according to the CIA Factbook looks like this:

• Mining and extractive industries producing coal, oil, gas, chemicals, and metals
• All forms of machine building from rolling mills to high-performance aircraft and space vehicles
• Defense industries including radar, missile production, and advanced electronic components, shipbuilding
• Road and rail transportation equipment
• Communications equipment
• Agricultural machinery, tractors, and construction equipment
• Electric power generating and transmitting equipment
• Medical and scientific instruments
• Consumer durables, textiles, foodstuffs, handicrafts

The World Bank has a Doing Business Index in which Russia currently ranks #120 in the world (#1 is best). Mr. Putin wants the country up to at least #20 by 2018. If you think that this wish makes it time to invest in Russia please remember that Russia produces as many bureaucrats as the Ukraine produces potatoes. Unlike potatoes bureaucrats are not consumed. They multiply. While good fundamental analysis is essential to profitable investing it can be difficult to factor in the costs in Russia of a bloated and recalcitrant bureaucracy. A place for possible investment in Russia will be the group of companies that may be privatized in the coming years. These will not be in defense or natural resources.

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