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The $9.2 Billion Bet Against OPEC Dominance

The $9.2 Billion Bet Against OPEC Dominance

The $9.2 billion investors paid to snap up new equity offerings from U.S. oil companies in 2016 proves those investors are indeed ready for more punishment.

The amount is in line with the pace of such equity offerings in 2015 even as the mood in the oil markets has grown increasingly dour. In June of last year I wrote:

New investors in U.S. oil company shares must believe they are catching the bottom and will have a very profitable ride up from here. This demonstrates that OPEC's work is not done and accounts in part for the decision to leave production quotas unchanged. OPEC's next task is to convince those making new investments in oil that, rather than catching a bottom in oil prices, they have caught a falling knife.

Related: Oil Continues To Rally As Short-Covering Continues

A lot of investors did end up catching a falling knife as oil careened downward from about $60 a barrel last summer to Friday's close of about $36. Investors this year may still find that the knife is falling, though it admittedly doesn't have as far to fall this time around. Still, it seems they misunderstand OPEC's strategy or believe that that strategy will fail. As I said in the same piece:

The cartel must dampen enthusiasm for investment for the long term if the organization's members are going to benefit. A crippled U.S. oil industry without friends in the investment world is the only way to assure that rising prices won't simply lead to a stampede back into U.S. shale deposits.

It seems that the oil industry still has friends in the investment world and that OPEC's work is therefore not yet done. The big question then is: Will OPEC stay the course or relent with a production cut this year to raise prices?

Related: Will Russia End Up Controlling 73% of Global Oil Supply?

I doubt that OPEC will relent. As bad as the OPEC countries, including Saudi Arabia, are hurting, to give up at this point would make all the previous suffering pointless. Saudi Arabia is really the linchpin in OPEC. No member can resist the will of the Saudis because they control such huge and flexible oil flows.

I have posited a speculative, but nevertheless plausible reason for why Saudi Arabia may not give up on its strategy any time soon: The kingdom may be at or near its all-time maximum rate of production, a rate it may only be able to maintain for the next decade or so. Naturally, the Saudis want to maximize their revenues during this period of peak production. They can't do that if U.S. oil companies keep overproducing.

Related: Oil Fundamentals Could Cause Oil Prices To Fall, Fast.

If the Saudis can neutralize those companies, by bankrupting them or forcing widespread lease sales, this will allow major international oil companies to buy up much of these distressed assets. The majors will develop these properties more slowly than the independents did because 1) the majors do not have to worry about their ability to meet debt payments and 2) the majors do not want to crater the price of oil which would only undermine the value of their newly acquired leases.

It is hard to imagine that the Saudis launched their low-price strategy on a wing and a prayer without thinking through how long it would take to force other producers to stop overproducing. But, investors keep hoping that the Saudis don't really know what they are doing. So far the Saudis appear to have the upper hand, and I'm guessing that those buying newly issued oil company shares these days are miscalculating once again. After all, the funding derived from these share offerings will only serve to encourage continued overproduction by making it possible for producers to hang on that much longer in hopes of an upturn.

By Kurt Cobb

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  • Dean on March 08 2016 said:
    I partially agree with this article. My main disagreement is with a statement I see too often & is propaganda or just backward thinking. The statement that the U.S. is over producing , or has ever over produced is the most absurd & incorrect calculation I have ever heard. The U.S. barely produces only "HALF" 50% of our daily usage & demand. We import the other 50%. Other countries around the world , only export what they don't need for domestic demand. Conclusion ,,,, The U.S. does not , nor ever has it over produced & never will.
  • Brett Miller on March 08 2016 said:
    1. If we could build refineries on the continent, such as in the wastelands of California Valley, we could refine our own product, whether sweet or heavy and not have to export what we can't refine and import what we can.

    2. There are capped wells in and around Ely, Nevada that are just waiting for liberals like Harry Reid to allow refineries to be built.

    3. Don't overlook the bully from Russia. If there's anyone ruthless enough to blow up a few Saudi or Libyan wells or pipelines, it's "he who shall not be named".
  • Paola on March 09 2016 said:
    @Dean: Of course the US is overproducing. While it is true that you guys are consuming more than you can produce, the actual problem lies in your massive consumption per head (and the ever-growing population). If you need to overproduce every single piece of remaining oil at a monstrous rhythm and for absurdly high costs per liter to keep afloat, you should really reconsider the way you're doing things up (just to start with, how unsustainable it is). All the other countries aside the Saudis are being really careful with their resources.
  • Carter on March 09 2016 said:
    @Paola

    #1. Our reserves are far more sustainable than anyone else's in the world barring, of course, unconventional reserves being found in the Middle East. Just because we won't produce it at the current price does not mean it disappears, new unconventional reservoirs are being found on nearly a daily basis in the continental US, it'll be there long after the 2053 cut-off for conventional reserves.

    #2. Why do we have to take a back seat at the table? If we are able to produce and make money (which we can even in the current market), why should we curb our output so as to solidify the countries globally that hate us the most? Seems counterproductive.

    #3. US E&P companies have lifting costs in the Permian Basin roughly equivalent to that of most producers in the Middle East. Even Exxon came out and admitted that they can explore and produce for roughly $11/bbl in the Permian, they simply aren't doing it because they believe it will rebound and why produce for $30 when you can produce for $60 in 2 years? It's a dangerous game that the Saudis have decided to play, shale has become more economic in the last year to produce than the 20 years before and that was 100% driven by this price crunch. They effectively just nailed their own coffin shut and did nothing but help trim the fat on the American oil field.
  • dhewitt on March 09 2016 said:
    You said "Naturally, the Saudis want to maximize their revenues during this period of peak production. They can't do that if U.S. oil companies keep overproducing."

    Are we talking Bernie math or arab intelligence? If they were to persuade OPEC to cut 10 percent they would see oil back at $90 bbl and save 10% of their diminishing supply. The real issue seems to be that the "informed" people in the world have determined that we are seeing the dawn of oil. Yet, several billion people in the world have not yet benefitted from the consumption of it other than a dirt floor with an electrical cord. (The cord was made from oil based products). It seems like we are dealing the with rational of the dot com era. It is a nightmare when money and stupid people with no class are the same name on the bank account.
  • Matt Novak on March 10 2016 said:
    Saudi oil output is largely a product of US political influence. This has been true since 1945. Has anyone noticed that this is a presidential election year in America? Politicians love low gas prices. Furthermore, there is a strong foreign policy aspect at work as well. The US government also wants low oil prices in order to cause political instability in certain countries on its enemies list that are susceptible to them by virtue of being oil dependent. Currently, the targets of this scheme are Venezuela, where it is working, and Russia, where so far it has not.
    The Saudi considerations that Cobb discusses may well be true from a purely Saudi standpoint, but they are secondary considerations to US dominance.
  • MikeSpinelli on March 10 2016 said:
    US oil company bank facilities are holding up quite nicely. Banking is banking on an eventual rise in oil prices. How eventual doesn't matter. They will go up at some point in time, just do to US rig count reduction. Saudi's won't bleed forever, and Kuwait, UAE, Qatar. Venezuela begging on it's knees, and the Russian bullies will find a way. Politically perhaps some collusion with US and Saudi Arabia wanting to unfund civil wars in Syria and Iraq. But, sooner or later they have to pay for that 160,000 man coalition with oil revenues. We'll see higher prices sooner rather than later.
  • Rusty Brown in Canada on March 13 2016 said:
    "...After all, the funding derived from these share offerings
    will only serve to encourage continued overproduction by
    making it possible for producers to hang on that much
    longer in hopes of an upturn..."

    But what if that is untrue? It would destroy the whole argument of the piece.

    What if "the funding from these share offerings" was being used instead to reduce debt and interest costs, without going into the production side at all? That would be an entirely different story.

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