Will the Oil Glut Cause a Drop in Price?

The world is awash in oil. From the US to the Mid East oil supply is outstripping demand. It is already causing disruptions in worldwide delivery systems.

Let’s first of all look at the United States oil. We now import only ½ of OPEC’s world supply at 5.5 million barrels per day. That is roughly half of what we imported 10 years ago. Now add to this an another 1 million barrels a day of US production from oil shale. What this means is that the US will be the top oil producer by 2016, pushing Saudi Arabia into the number two spot.

Moving to the Mid East, the oil glut is even more intense. Some countries will fall in line with OPEC and others will go their own way. Iraq will bring 300,000 barrels per day online this year. Venezuela is estimated to increase production by 250,000 bpd. Libya, which has been in turmoil, has
stabilized its oil fields and will bring 600,000 bpd to market. Iraq, Venezuela and Libya will most likely keep producing and only make token concessions to OPEC. The United States has made overtures to Iran and lifted some sanctions that drove the Iranian economy into a deep recession. It is now able to bring another 1 million bpd to market.

This added supply is putting pressure on OPEC to cut production by a whopping 25%. Saudi Arabia is having internal problems with the ruling minority having to deal with protestors and demonstrations.

At present, the only variable keeping oil prices at these high levels is the turmoil in Ukraine. This has created a $10 spread between Brent crude and WTI crude.

Big oil knows it is facing a potential sharp drop in oil prices. They are putting pressure on the Administration to open up US oil exports. This would keep prices high and companies would be able to maintain their high profit margins. This, however, would hurt the American consumer. This debate is gaining momentum and will be a “hot button” issue for US politicians.

Oil analysts have studied the oil glut of 1986. It caused the price to collapse by 65%. Maybe we don’t remember that oil was near $10 per barrel during the Clinton administration. It remained under $20 per barrel from 1986 to 1999. There is a growing fear among oil producers of another such collapse. The best guess among oil analysts is for a drop of $25 per barrel this year.

The issue of pricing is quite different now. The cost of production for shale oil is estimated at $70 per barrel. A sudden, sharp drop in price would squeeze profit margins for shale producers, perhaps forcing some out of business.

For the investor, the energy sector is the one to watch. It might be helpful to start tracking a gauge such as the oil index. You also want to follow the political discussions underway on the topic of oil exports. If the trend turns down, you might consider inverse ETFs on the oil sector.

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