The
components of the current low oil prices represent an insidious and toxic
economic brew. The sustained long-term low oil prices, are a result of
continued record high production domestically and internationally, excess
inventory, tepid demand led by a slowing Chinese economy, and a strong US
dollar in which oil is priced. Consequently energy firms have mothballed or
outright cancelled mega energy projects worldwide totaling $380 billion which were undertaken years
earlier during boom times to meet future global energy needs.
With
respect to production, both OPEC and non-OPEC countries have been producing
flat-out because of the need for revenue. The biggest producers are Saudi
Arabia and Russia, the former because of unanticipated expenses supporting a
war in Yemen and increasing domestic needs, and the latter because of
Western-imposed sanctions. Iraq is continuing their record production, Iran
will soon enter the world market with a bountiful of oil stored in supertankers
and the US, despite some shale oil company financial difficulties, are still
strong producers particularly with the new crude oil exports.
The
restarting of mothballed projects is an operationally and financially
complicated affair during a demand upswing for the following reasons:
1. Operationally, getting
these projects back on-line will not be accomplished before the excess
inventory is reduced.
2. Financially, oil
companies may be reluctant to commit to continuing particular projects or will
decide to have a limited restart because of the uncertainty whether new demand
will continue to remain strong.
3. Finally, the
continued strength of the US dollar has limited the ability of many countries,
particularly those emerging economies, from purchasing more oil to meet demand.
For
this reason, these components represent a set-up for a brutal super-spike in
oil prices for an inevitable market correction when demand rises which reduces excess
inventory and the US dollar declines. Even with a modest increase in
demand, excess inventory will vanish and without any new oil operations coming
on-line in the near future, oil prices will steadily increase. Accelerating
this process will be the decline in the US dollar as more countries are able to
afford to purchase more oil to meet demand. At the same time energy
companies will be scrambling to rehire oil workers and energy services, a
highly specialized field, which could result in a bidding war for services raising
operational dramatically.
It
is important to note that these components will not necessarily move in
synchronized lock-step, rather in a somewhat staggered fashion. Nonetheless,
whichever component shifts first, the period from the initial change will be
only a matter of months, not years before oil prices surge dramatically and
remain elevated until new oil production operations are on-line.
The
most likely scenario for the beginnings of an oil price increase would be the
depreciation of the US dollar whose current lofty value is unsustainable and
its decline precipitous. Because other commodities in addition to oil are
valued at or near historic lows, the opportunity for countries to make large
purchases immediately with a depreciated US dollar will be difficult to pass
up. The result could be a sudden burst of intense purchasing activity for oil
to transport these goods as well as to operate the industrial operations to
process these raw materials.
The
demand upticks may also come from China who is in the midst of diversifying
their military, converting it from a largely land based military to a leaner, more
muscular land, naval, air and cyber military force. For this reason they will
take advantage of the lower US dollar to purchase oil to increase their
strategic reserves.
Again,
the timing of when this demand surge will occur is speculative however the
components are in place for such a dramatic change in prices to occur.
Certainly investments in oil, gas and energy related services should be
strongly considered to take advantage of this upcoming energy price spike.
This
article was published in SeekingAlpha.
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