Oil prices dropped 3.8% Thursday, and could have dropped even further if not for news that oil-and-gas giant Halliburton (HAL) was considering a bid for oilfield services company Baker Hughes (BHI).
Overall, oil prices have dropped more than 30% in the past four months. Yet the recent price correction that’s been under way in oil may already be starting to abate, starting with Friday’s 2.2% gain.
My working hypothesis on the recent price decline has been focused largely on Saudi Arabia.
Its royal family and other oil-rich Sunni kingdoms in the Middle East have conspired to allow roughly 1 million barrels a day to build in the world oil market.
They’ve been doing this to achieve two goals.
Goal #1: Undermine and cripple Russia’s economy.
Every dollar decline in the world price of crude oil brings Russia closer to defaulting on its debts and financial obligations.
This move is in retaliation for Vladimir Putin’s continued support of Iran and Syria with monetary and military assistance.
Russia needs the world price of oil to return to at least $105-$114 per barrel to generate enough cash to pay its bills.
Goal #2: Discourage the development of U.S. and Canadian oil sands and shale oil resources.
The sheer size of potential oil production in the U.S. and Canada can’t be ignored.
By keeping crude oil below $80 a barrel, many oil development projects in North America will be mothballed and frozen.
News broke Friday night that the Keystone pipeline bill had passed the House and was on its way to the Senate. Some political observers expected the bill, which proposes to speed construction of the pipeline, would pass the Senate, too.
However, lower oil prices do have their benefits, and not just for consumers experiencing their first taste of winter weather.
The lower price of oil also serves the Obama administration and our NATO allies.
First, I want to be clear about something. The big decline in the world price of oil over the past several weeks has very likely come to an end.
The indicators Geoff Garbacz, Dan Hassey and I use in the short term are telling us we could see healthy rally in oil that could push WTI back above $80 even $90 in the next few months.
Still there is risk of FIRST seeing oil prices push even lower in the short term.
We could see another $10 to $15 Saudi-induced oil price drop.
And while the U.S. economy survives just fine — and even benefits — from lower prices, Russia’s economy on the other hand suffers a multibillion-dollar blow.
And outside of a handful of its closest allies like Syria, not too many people will feel sorry for Putin and the problems he will face.
Poor Putin? Not So Much
That’s because Russia heading into financial dire straits may help discourage it from seizing the entire Ukraine — and, for that matter, many of the former “prisoner states” that were under the fascist boot of the former Soviet Union.
While I’ve been an unflinching oil bull for many years … and I remain VERY bullish on oil in the long term … the near-term oil situation is enough to keep traders awake at night.
At this very moment I see the possibility of crude oil being intentionally pushed potentially as low as $63 a barrel.
Right now there’s a million-barrel-per-day oil surplus that normally Saudi Arabia and OPEC would deal with by cutting its oil production and supply into the world market.
The Saudis, however, are making no such adjustment to their oil supplies to the world market.
This is weakening investor confidence in the oil market.
It’s putting oil into a weak psychological position — one that could force the price of oil even lower … even as our key indicators are telling us the bull market in oil is on the verge of re-asserting itself.
Oil has dropped from a peak of over $140 to now about $78-$62!
At the core of the problem is the reality — the world oil market is NOT a FREE MARKET!
A million-barrel oil surplus wouldn’t normally be enough to create a bear market strong enough to push oil down to $60.
Psychology underpinning the market can be more powerful than the actual supply/demand situation.
But the fact is, oil has been at the mercy of the Saudi royal family and OPEC since the early 1970s — back when the first Arab oil embargo took place.
Now 40-plus years later, the Saudis still dominate OPEC.
But they have also become so powerful that they can impose their will on the oil market — even if it excludes other member states of OPEC that are aligned with Russia.
The Saudis’ control over the world’s oil market is pretty remarkable.
The Saudis could drive oil prices sharply higher simply by announcing a production cut.
Instead, the Saudi royal family chooses to keep extending the surplus of oil in the world’s oil market.
The surplus, combined with the negative impact of Western sanctions, is dramatically weakening the Russian economy.
This clearly being confirmed by the financials we’re seeing coming out of Russia…
- The Russian ruble is down 33% in 2014.
- Russian stocks are down almost 50% since mid-2011 … and trending lower.
Ruble/U.S. Dollar Currency Pair
Market Vectors Russia ETF (RSX)
Source: Yahoo! Finance
Could History Repeat Itself?
It’s helpful to keep in mind that — despite having tens of thousands of nuclear weapons, tanks, bombers, jet fighters and an army of over 1 million soldiers — the Soviet Union collapsed because oil prices slid from over $30 a barrel to just over $10 a barrel.
Unable to access the West’s capital markets, the Soviet empire slowly collapsed.
Unemployment reached 60%. Things got so bad that active-duty Soviet soldiers actually wandered the streets in tattered uniforms, begging for food and shelter.
The Saudis can afford to let the price of oil hover between $60 and $70 for years if needed. Russia and Iran cannot wait that long.
Sanctions on Russia’s finances make it impossible to borrow from Western markets.
Russia: Getting by With a Little Help from its Friends?
China is quickly becoming Russia’s biggest energy customer thanks to its growing demand.
And for now the Chinese are helping a little, by securing loans against Russian natural gas and oil reserves.
While the loans and sales of oil and natural gas are helping the Russians generate enough cash to cover the country’s bills, this Chinese-Russian arrangement has a big downside for Russia.
It locks in a set discount in the price of natural gas and oil. This is in exchange for the guarantee the Chinese will buy a minimum amount of oil and gas from the Russians.
If the price of oil and natural gas are high, the agreement works fine for Russia. However …
If the price of these commodities is very weak, the agreement can be a disaster for the country.
Think about this — if the price of natural gas and oil stay weak (and weaken further), then Russia could wind up selling its oil and natural gas for less than it costs to produce.
How Russia Could Lose a Half-Billion Dollars a Day
In fact, if the world price of oil does sink to $60 a barrel, the Russians could lose up to $45 million on the sale of every 1 million barrels of oil it sells.
Assuming Russia needs $105 a barrel to cover its national budget, at $60 a barrel it would be upside-down by $45 a barrel.
Multiply that by 1 million barrels — a loss of $45 million a day.
Keep in mind that Russia sells 10 million barrels of oil (and oil equivalent) daily. So it could wind up losing $450 million — almost a half-billion dollars — a day if the world market price for crude oil dips to $60 a barrel.
This kind of economic black hole could turn Putin from a perceived hero by the Russian people into the villain the rest of the world sees.
Why Sub-$70 Oil is Great for the Stock Market
The upside of this Saudi/Russian oil war is that, if the oil market is hit hard for even just a short period of time, it will create some incredible low-entry-price opportunities in some of the best-run and oil-rich exploration-and-production (E&P) companies in the world.
On any sudden move in the price of WTI oil below the $70-per-barrel level, I intend to recommend jumping in and buying all sorts of junior and senior E&P companies.
The reality of lower oil prices — especially below $70 for WTI — is they can’t really last very long.
That’s because WTI at $70 or under would act as an incredible stimulus for the world economy. The cumulative savings and efficiencies would likely jumpstart European and Chinese economic growth by 2%.
Heck, the U.S. could see economic growth jump an additional 3%.
This irony of all this — the prospect of the lower oil prices seriously threatening Russia’s economy and Putin’s presidency while, at the same time, jumpstarting the U.S. and world economy with cheap energy prices — shouldn’t escape you.
Neither should the opportunity to make money from it all!
Always Watching Your Chickens,