Saturday, November 1, 2014

October's Best Good News Story ... The Developing Glut in the Global Oil Patch ... It's Back to the Future

Keenan's post today in part is about getting our U.S. economy back in shape and that simply taking from one party to give to another party (redistribution) won't make our overall U.S. economy stronger. Simple thoughts make for insightful analysis, and Keenan hit the nail on the head with this one. If votes are what the politicians are after, and they are, then all of We the People must be on guard about what the pols say they are doing for us. The fact is that more often it's what they are trying to do to us that requires our immediate and lasting attention.

That said, maybe after having now read Keenan's common sense posting, I'll even have the good sense to eat a bit healthier and take in a lot fewer calories each day. As he said, it's total calories in and calories out that matter. Now that's pretty understandable, even for me.

But now let's pause and take a minute to enjoy the fact that the stock market ended October in strong fashion, with the Dow overcoming an early-in-the-month drop of 5% to rally strongly and finish at an all time high yesterday of 17,391. The broader S&P 500 index also closed at a record 2,018. And all this came after excellent gains for September. While it probably won't be all smooth sailing from here, my crystal ball still says that the market is headed for a higher close by year end.

And one huge reason that things are looking up is the energy story. Of course, energy prices affect all parts of the U.S. economy, including consumers and businesses, as well as impacting government's tax take as well. Lower inflation means more money in consumers' pockets to either spend on new things or retire burdensome debt levels. Lower inflation also means more money for businesses to share with either consumers or their shareholders in the form of higher profits. And more profits mean more jobs and more taxes for the government's coffers as well, as this all leads to greater investment, increased dividends and higher stock prices for shareholders, including pension funds and 401(k) owners. And lower inflation also means continuing low interest rates too. That helps borrowers (including government borrowers) and also makes stocks more attractive relative to bonds and other assets. As an American, there's lots to like about the game changing and rapidly developing energy story. So let's tell it like it is.

Lower energy prices and greater energy supply are going to be a great way for the U.S. to get 'back in shape.' Even Hillary Clinton should be able to understand that. Now we need some common sense governance, including the approval of the Keystone pipeline and the removal of government restrictions concerning the export of America's vast crude oil supply. So let's take a deeper look into October's continuing good news in the global oil patch.

October was an eventful and busy month in many areas of the global economy, but the oil story stole the show. There is a developing trifecta with all three arrows pointing to ample supply, if not a glut, in the midst of (1) higher supply coming from North America, (2) more intelligent conservation, and (3) lower demand from the weaker economies of China and Europe. We'll tell the story in terms of gasoline but it applies to every drop used in every situation and form, including transportation, business and residential use, as well as oil, natural gas, coal, nuclear and solar too.

A few weeks ago, we predicted that $2.50 per gallon gasoline was likely. {Please see the post "Oil Price War Continues ...." dated October 16.) See also Gas prices to drop below $3 for the first time since 2010.)

Today let's update what as recently as two weeks ago was my 'going out on a limb' guesstimate. My current view is that the $2.50 per gallon prediction looks very realistic. And that's simply because free market pricing in the global oil patch, led by the U.S. shale oil revolution, is replacing the OPEC cartel's decades long price fixing ways. In fact, The North American producers (politicians willing) will be the world's low cost and high volume energy producers, thereby capable of assuring that energy prices will be established pursuant to the laws of supply and demand. And that's a very big deal in all kinds of beneficial ways for U.S. consumers, businesses and national security.

Helping the cause is that retaining their current market share is extremely important to the Saudi Arabians. In that regard, their well justified distrust and dislike for Iranian and Russian leaders suggests that Saudi production levels won't be declining anytime soon. As a result of the foregoing factors, U.S., Canadian and Mexican sources of supply will now be calling the shots and the free market will be determining price levels in the global oil patch. On top of that, slowing economies in Europe and China, combined with better energy conservation techniques in the U.S., are also making conditions ripe for a price war due to the developing worldwide oil glut.

So perhaps it's time to update that two week old guesstimate and lower the predicted price per gallon from $2.50 to $2.25, or perhaps even lower.

And if any of those distinct possibilities prove to be the case (even if the price per gallon 'only' falls to $2.50), then this year's Christmas selling season should be a very merry one indeed for America's consumers, retailers, shippers and the companies that provide them with products they buy, sell, move and make. Restaurants and other discretionary sellers will also enjoy the benefits of there being additional money in the wallets of America's shoppers.

We haven't experienced anything like this gasoline pricing for a very long time, so it's natural not to get our hopes up. But let's remember that not more than a year ago, prices below $3.00 per gallon seemed like an impossible dream.

But now we're learning anew that the law of supply and demand still applies, and that we in North America have more than an ample supply of energy. Thus, there's simply no foreseeable reason for energy prices to stop falling anytime soon. The high cost producing and price fixing bad guys from OPEC, Russia, Venezuela are on the run. And that's a very good thing.

Energy Boom Can Withstand Steeper Oil-Price Drop summarizes the current situation in the oil patch:

"Oil prices would need to fall at least another $20 a barrel to choke off the U.S. energy boom, industry experts say, though some smaller American producers would face serious problems from a more modest decline.

Small and midsize companies—not global giants—are behind the surge in U.S. oil output, which hit 8.97 million barrels a day earlier this month, according to federal statistics. Some of these drillers have taken on a lot of debt, which was easier to justify when oil was going for as much as $107 a barrel just four months ago.

U.S. crude closed Wednesday at $82.20 a barrel, and far less in some parts of the country where few pipelines are available to move it to refineries. Lower oil prices mean drillers will have less cash to cover their borrowings, especially if crude prices tumble more.

"So far, American companies haven’t reacted to the recent oil-price drop: The number of drilling rigs searching for onshore oil in the U.S. has risen slightly since oil prices peaked June 20.

The Organization of the Petroleum Exporting Countries seems to be betting that will change soon. Abdalla Salem el-Badri, OPEC’s secretary general, predicted Wednesday that if current prices hold, half of the U.S. oil that is fracked from shale formations will be uneconomic, leading companies to stop producing it.

That view is at odds with most U.S. forecasters, who say output can remain steady at current prices because companies have cut their costs by finding ways to produce oil more efficiently. For example, the amount of oil coming from each new well in South Texas has nearly doubled since 2012, federal data show.

Marianne Kah, chief economist of ConocoPhillips , said oil prices would need to fall to $50 a barrel “to really harm oil production” in U.S. shale basins. She said 80% of the American shale sector—in which ConocoPhillips is a major operator—is profitable at prices between $40 and $80 a barrel for benchmark West Texas Intermediate crude.

Jason Bordoff, director of Columbia University’s Center on Global Energy Policy, said he believed prices would have to fall much further to put significant pressure on the U.S. energy boom. “I am not sure if $80 is enough,” he said. “You might need $60 or $65 to really see a stress test.”"

Summing Up

With oil selling for ~$80 per barrel currently, prices at the pump have fallen below $3 per gallon.
Should oil prices keep falling, which I believe they will, we may see the price of gasoline fall to as low as $2.25 per gallon, or perhaps even lower. 

But with winter dead ahead, this is no time to get irrationally exuberant. Accordingly, I'm betting on regular gasoline in the U.S. being sold at ~$2.50 real soon and maybe as low as $2.25 per gallon early in 2015. Beyond that my crystal ball blurs.

But look for the $2.50 to happen, and before year end.

And if that's the case, my fellow Americans, we should enjoy a very Merry Christmas shopping season. Maybe we'll even use some of the 'new money' to reduce the amount of consumer debt as well.

But whatever we choose do with that 'redistributed money' (from OPEC to us), we'll be getting in better shape, and that's a good thing.

That's my take.

Thanks. Bob.

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