Red, red, red… they should call it a Red Friday instead of Black Friday, because the only color you’ll be seeing when it comes to oil prices is red! If you’re an active trader, this should sound like an early christmas, but if you’re an oil producer, these days look more like the great depression than anything!
Oil prices have bee slumping like crazy, with Crude Oil (Brent) hitting $71 per barrel and Crude Oil (WTI) in the upper 60s as of today. Back in the days this wouldn’t be much of a problem because the oil monopoly OPEC can easily stabilize the prices by cutting production and driving the cost of the barrel up. The only problem, shale oil producers are not into the monopoly game, and the increasing share of shale oil in the petro-market is making supply cuts ineffective.
It seems like a downward spiral from here on, and it would be wise to say that selling your energy stocks is the best decision at the moment! Wrong!
The fact that OPEC, led by Saudi Arabia and other oil giants in the Gulf, aren’t reacting strongly to the slumping prices is an indicator that there is more to the story. One wouldn’t be surprised to see the oil states letting prices slide on purpose, especially KSA; that way they can drive the shale oil industry in the US out of the market. Shale oil is commercially viable only at high oil prices, and because of their low profit margins compared to traditional oil producers, once the prices slump to 70 or 60 dollars per barrel for a long period (1 to 3 years) they can be driven out, leaving OPEC with its monopoly again. Survival of the fittest.
Small cap Shale oil companies are already suffering, with Forest Oil falling below $1 a share and Halcon Resource Corp losing half its share value over the last 3 months. Goodrich Petroleum, another small cap shale oil firm, lost 60% of its value. It’s early christmas for funds who are buying companies at half the value they were trading at just 3 months ago!
Fund managers are considering this scenario as highly likely, prompting hedge funds to aggressively buy energy stocks as reported by Reuters. Small cap shale oil investors are already rushing towards the exit door, and several fracking projects are being rolled back in the US. OPEC members are far from being dumb, and when you’re a country with a $750 Billion sovereign wealth fund as in the case of Saudi Arabia and the UAE, bleeding for a while isn’t much of an issue. Shale Oil companies and investors might be well capitalized yes, but not to the extent KSA, UAE or Kuwait are. Saudis can survive on losses for years, shale oil companies will run out of capital in way less. It is worth noting that Shale oil companies are accountable to their shareholders, and every loss counts, but for OPEC countries, they can act at a loss without worrying about much.
It’s a war of attrition, and all the prospects indicate a probable win for the petro-states. It’s time to buy in oil and sit on it for a while. Prices will go up again once OPEC’s monopoly is restored and Shale oil is brought to a commercial death, and the only question you’ll ask yourself then is: Did I make money out of it?
Photo Credit: Bloomberg