Crude oil is up over 40% from its multi-year low in the mid-20s just 25 days ago – futures are up even more. The narrative surrounding oil is changing as prices stabilize and a new catalyst in the form of western central bank intervention arrives. That’s right, central banks want to save oil prices…
Oil Prices rebound as Rig Count Hits Record Low
Like any commodity, if the price falls below the level profitable to extract it, exploration is discontinued. Risk capital and wildcatters vanish. With global growth not expected to be the engine driving oil prices in future years, we have to go deeper to learn how the delicate balance between supply and demand, central bank intervention and economic stability will be managed. Oil price manipulation will be a factor in the years ahead.
Central bank policy and geopolitical forces are set to play the largest role in oil’s price for years to come…
While the Saudis have executed their plan to crush U.S. and Russian oil producers, which we outlined in January 2015’s The Orchestrator of Oil’s Collapse, it’s hard to imagine they thought such severe damage would be inflicted by their decision to abandon OPEC and pump oil.
Following a Houston energy conference in late-February, in which the Saudi oil minister spoke, Jeff Gaulin, vice-president of communications at the Canadian Association of Petroleum Producers (CAPP), stated:
“The challenge that we got from the Saudi minister was this: Cut your costs or get out of the way.”
Regrettably, with oil prices below $50 per barrel, many North American producers have been getting out of the way.
Oil and gas exploration in the U.S. has declined to levels not seen since the 1860s…
Oil and gas companies have slashed expenditures to the point that there are only 480 rigs still actively drilling in the United States, according to Baker Hughes’ latest rotary rig count. This is 8 less than the previous all-time low of 488 rigs – hit in 1949 following World War II. Averaging it out, the U.S. currently has less than 10 active wells per state. Texas leads the way with 215 active drills – nearly half the country’s total.
Canada’s collapse is even more shocking than its southern neighbour’s. Canada is now down to just 98 active rigs, according to Baker Hughes. Active rigs in the country are down more than 35% since late-February. Incredible.
Both Canada and the U.S. have lost more total drills in the past year than they currently have drilling.
In respect to the 1860s reference, Paul Hornsell, head of commodities research for Standard Chartered Bank, stated:
“While there is no consistent series for drilling activity before 1948, we think it likely that to find a lower level of activity would require going back to the 1860s, the early part of the Pennsylvania oil boom.”
source: http://www.bloomberg.com/news/articles/2016-03-02/oil-and-gas-drillers-i…
Although we recommend caution, if the bottom is in fact in, the returns from many oil and gas stocks we’ve seen in the past few weeks could be just the beginning.
Let’s be clear, we don’t believe oil is heading back to $90 per barrel anytime soon, perhaps not for years; however, there are dozens of companies that can make money in Canada and the U.S. at $45 oil. While costs vary even within regions of countries, the below chart broadly highlights which nations need the price of oil to rise.
According to Market Realist, the below chart shows the total cost, on a per country basis, of producing a barrel – including, “all of the costs from project site plan development to lifting oil from the well.”
Canada is in 3rd at $41 cost to produce one barrel, with the U.S. in 4th at $36.20 per barrel. The price of oil is currently trading in the $38 range.
With Brazil and Russia in recession, and the U.S. and Canada nearing the same, policy makers, namely central banks, want the price of oil higher…
Oil Prices Top of Mind for Central Bankers and Policy Makers
As if the complete discontinuation of exploration for oil wasn’t enough, political forces that run the world have shared growing concern over the price action in oil over the past 90 days, and they are preparing to take action. Never underestimate the power of central banks and policy makers. You do so only at your own peril in these politicized times.
Think about the oil markets from a political standpoint for a moment. We’ve discussed Europe’s motives to embrace clean energy and COP21 (given the EU imported north of 90% of its oil in 2013); but, are economies in the U.S., Canada, Norway, Venezuela, Russia, the U.K. (and many others) strong enough to survive this dramatic collapse in price for much longer?
The answer is a resounding no and politicians understand this. Therefore, the mere potential for policy intervention has already begun to reverse and stabilize the price of oil.
In early-February, as the oil markets tanked to generational lows and the global financial markets teetered on the brink, central banks took action. The Bank of Japan took rates negative at the end of January and reiterated with the ECB they were willing to do “whatever it takes” to support their respective economies and fight off deflation.
What spurred global central bank action? The justified fear of contagion.
Given the fact central banks have been able to shore up confidence in other assets such as housing, corporate bonds and stock prices, is it realistic to assume they would support oil?
Of course…
Banks in Canada and the U.S. have massive exposure to corporate bonds in the oil sector – to the tune of hundreds of billions of dollars. While most of these arguably toxic assets have not hit the fan (yet), they could if oil stays below $40 for a few years.
The Wall Street Journal came out on February 23rd and proposed:
“…the Bank of Japan should print money to buy oil. It sounds beyond nonsense. But with central bankers believing six impossible things before breakfast, it no longer seems inconceivable, which is informative in itself.”
The power of central bank intervention is now as big as it has ever been. Think back over the past decade or so. After QE1 faded, the Fed came with QE2, then Operation Twist, QE3 and you can bet QE4 is on deck when Yellen finally admits the US is in recession.
Bryan Rich of Forbes reported a few weeks ago that,
“In 2009, despite the evaporation of global demand, oil prices spiked from $32 to $73 in four months after China tapped its $3 trillion currency reserves to snap up cheap commodities. Within two years, oil was back above $100.”
Can it happen again? No doubt. Policy makers have intervened throughout history to boost demand for bonds, stocks, oil and other commodities.
Bloomberg reported in a Wednesday morning article that:
“The path of U.S. monetary policy may be shaped as much by what happens in Frankfurt and Tokyo over the next seven days as it is in Washington.”
On Thursday, March 10th, the ECB expanded the scope of its asset purchase program to include“Investment-grade euro-denominated bonds issued by non-bank corporations,” according to the central bank.
Lines are being crossed all around us as central banks rush to shore up confidence in the face of mounting deflationary pressure. Corporate bond debt linked to the oil sector is in the trillions of dollars globally. In January, CNBC warned that $99 billion of high yield energy bonds are trading at distressed prices; and now, at least for euro-based companies, this type of debt is on “the list of assets eligible for regular purchases under a new corporate sector purchase programme (CSPP),” according to the ECB.
If the BOJ follows the ECB by easing further and engaging in another asset buying spree, the U.S. dollar will rally, forcing the Fed to sit tight on a rate hike. This will be inflationary, and bullish for oil.
The energy sector in the US accounts for nearly $1 trillion in GDP each year. The US government is not willing to give that up in a matter of months, even with renewables building momentum. The transition has to be done orderly, and over decades, not in a few years at the behest of a price war orchestrated by the Saudis.
Policy intervention and the politicization of the energy sector will lead to manipulation of the global oil markets (by the West) and concessions being made by Saudi Arabia. This, along with the supply glut easing, due to a lack of western drilling, will likely result in stabilization and modestly higher oil prices in the months ahead.
All the best with your investments,
PINNACLEDIGEST.COM
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