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OPEC Shenanigans May Impact Your Wallet and Your Investments
*** Saudis Step Up?
*** $30 Oil?
Dear American Capitalist Reader,
Don’t look now, but there’s a brouhaha developing within the halls of OPEC -- the Organization of the Petroleum Exporting Countries. The eleven member states think oil is priced too low and they want to manipulate the market by cutting oil production supplies in an attempt to boost prices.
Hmmm… sounds lawless to me and, unfortunately, there really isn’t anything we can do about it.
On Friday, two of the eleven announced a cut in production to limit supplies around the globe. Nigeria and Venezuela are reducing crude production by a combined 170,000 barrels a day. The bears returned in full force by bidding down oil prices and the result was a loss of 3% in yesterday’s trading.
In my opinion, traders are looking for greater cuts from other OPEC members. The combined 170,000 cut has little to do with the macro demand for the commodity because OPEC members only produce 41% of the world’s supply and a much greater figure would have to be cut in order to have a serious effect on crude prices.
In addition, the world currently enjoys a 500,000–1,000,000 barrel-a-day surplus; and until the demanded numbers exceed the supplied numbers, which is what OPEC members want, oil prices will remain in the low $60 range.
Why Cut Supplies?
The reason behind the production cuts is to boost the price for oil, which means higher revenues for oil-producing countries like Iran, Saudi Arabia and Venezuela, among others.
And, this manipulation affects everyone around the world because higher prices for oil mean higher prices for gasoline and heating oil for consumers. It doesn’t seem fair, but until a viable alternative fuel source or gigantic pool of the commodity is found off our shores, these OPEC members will continue to play puppet master with the prices so they can fatten their own wallets and shrink ours in the process.
Will the Saudis Step Up to the Plate?
You’re going to hear a lot of talk about why Saudi Arabia -- the largest oil-producing member of OPEC -- should cut production to boost prices. Saudi Arabia produces between 10.5–11 million barrels a day. Its influence is powerful because the next-largest producer is Iran with only 4 million barrels a day.
If the Saudis cut production by 5%, it would most certainly cause a spike in prices. But, here’s what investors need to keep in mind: The Saudis can’t cut prices. Oil is its main revenue source, and oddly enough, the country needs cash.
Despite higher oil prices, Saudi Arabia has a high unemployment rate, reported to be 13%, but some believe it to be higher. It also has a booming population, which requires more demand on government spending. Due to these issues, if the Saudis cut production, it essentially takes a pay cut even though Economics 101 would lead us to believe prices would rise.
But oil prices are not fixed and a 5% cut by the Saudis doesn’t guarantee an increase in revenues. In addition, the Saudis are businessmen and refuse to influence higher prices when other OPEC members are sitting back and hoping to reap the rewards without participation.
Prices Will Inevitably Inflate
All of this talk about production cuts doesn’t mean much because oil prices will go up on their own. Simple supply and demand factors are going to cause price increases, countries like India and China -- former underdeveloped countries turned 21st century economic superpowers -- are the catalyst for the increased demand.
Plus, we are quickly coming up on the raw, cold days of winter and heating oil will soon be in high demand. Seasonal factors, like winter, have yet to be included in the price for oil.
As investors, the lower prices create a terrific buying opportunity for your portfolio. Look for some of the higher quality, large-cap Big Oil companies as they still get to enjoy the historically higher oil prices, thus equaling higher revenues to the bottom line.
I have been invited to appear on CNBC this morning at 10:15 a.m. EST to discuss the shenanigans taking place among the OPEC members. I hope you have the opportunity to tune in, but if not, take a look at Diligent Investor as I provide daily updates on investor-friendly topics like crude prices and the effect on your investments.
Until tomorrow,
Todd M. Schoenberger,
Senior Equities Analyst, Diligent Investor
Over to BreakAway Investor’s Andrew Mickey with more…
$30 Oil: It’s Coming
Again, oil’s back down dangerously close to the $60 mark. The oil bulls are making excuses like, “increasing supplies are only temporary,” and “what if Iran or OPEC cuts production?” These are all excuses. Oil is going down and everyone knows it.
But here’s why… supply is catching up with demand. Continued investment in new rigs, oil service boats, drill bits and other equipment is going to continue to grow, and more and more new supply will be brought online to more than offset any declining wells or political rationing.
Just look at the global production and exploration (P&E) numbers. In 2004, P&E spending totaled $157 billion. In 2005, it topped $207 billion. This year, another $257 billion should be spent on developing new oil fields. That’s a pretty strong trend that’s going to continue well into the future.
In fact, in the last month alone, Rally Oil (RAL:CDNX) announced a $135 million P&E budget for 2007 and 2008. Mexico’s state-owned oil company Pemex declared its request to up its 2007 P&E budget by 30% to $12.9 billion. And these are just two of the most recent examples.
Continued investment in new oil production will cause oil prices to fall once again. It’s basic supply and demand. OPEC might not like it, but oil’s headed back to $30. Yep, I said it. Within four years oil prices will be back to OPEC’s “ideal range.” It’s all part of the boom and bust cycle of the energy industry.
I know it seems unlikely now. But it didn’t seem likely in the early years of the Reagan administration either. What will happen when it does fall back to $30? Think about it.
Will you and your portfolio be prepared? Ethanol will cool off and stockholders will be left holding the bag. The solar panels thousands of consumers picked up at the Home Depot will likely be found conveniently stored away next to all the other half-finished home improvement projects in thousands of half-finished basements across the country. And the $4,000 premium everyone paid to get their hands on a hybrid car will become something “they don’t like to talk about.”
Chrysler will be king of the car world. It won’t be able to produce enough gas-guzzling hemi V-8’s to satisfy the return of the American demand. Car companies will go back to stuffing as many airbags into a car as possible and filming commercials with close-ups of the J.D. Power & Associates trophy every car seems to win. And don’t even get me started about oil sands.
There are a lot of bets being placed on oil prices remaining high -- please take note that the Big Oil companies are not banking on oil prices remaining this high. They realize the downward spiral of oil prices over the past month proves the amount of speculative dollars that were being pumped into buying up oil. They aren’t even basing their capital budgeting decision on $50 or $60 oil. They’re planning on $30–40 oil.
There’s still plenty of opportunity left in the oil service industry, though. After all, these companies have a lot of work to do to get oil prices back to a reasonable level.
Finally, let’s take a look at the inflation-adjusted history of oil prices: In 1974, oil climbed to $40 a barrel. Oil lingered in the $30–40 range for almost seven years -- until 1981, when oil surged to $70.
Following that high, oil prices steadily fell back into the $40–50 range over the next couple years. Then, about five years after hitting $70, oil was trading at $15 a barrel and wouldn’t reach above $40 for any sustainable period of time for almost two decades.
If you want to play oil, and I encourage you to do so, put your money in the companies that will be playing a big role in getting oil prices back down to normal. Oil service stocks will remain highly profitable and will continue to grow, at least for a few more years. That’s where you’ll want to have your investment money.
Rig owners and operators like Transocean (RIG:NYSE) and diversified oil conglomerates like Exxon Mobil (XOM:NYSE) are not going to be continuing on their record profit streaks as oil prices decline. It’s going to be flexible service-oriented providers with fewer assets and greater flexibility who will be profiting the most.
So far I’ve beaten Morgan Stanley and Forbes to the opportunity in this play, but it’s not too late. You can learn more about my favorite way to play the oil service sector by clicking here.
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Earnings Announcements
Burlington Coat Factory, Lawson Software Inc, and Pepsi Bottling Group are releasing earnings.
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Unlock Dates for October 2006
Wendy’s will distribute its remaining 82.75% stake in Tim Hortons Inc on September 29, 2006. When these shares flood the market, look for THI to drop. THI has a PE of 19 as compared to a company like McDonald’s, which trades with a PE of 16, is much cheaper, and has more growth.
10/3/06 – Visicu Inc is unlocking 6 million shares.
10/3/06 – Castle Brands Inc is unlocking 3.5 million shares.
10/4/06 – Sealy Corporation is unlocking 28 million shares.
10/23/06 – Corel Corporation is unlocking 6.5 million shares.
10/31/06 – Delek US Holdings is unlocking 10 million shares.
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Upgrades and Downgrades
Columbia Sportswear downgraded by Citigroup from Buy to Hold.
Costco downgraded by Banc of America from Buy to Neutral.
Cryptologic downgraded by CIBC World Markets from Sector Outperform to Sector Underperform.
DR Horton downgraded by Credit Suisse (from Outperform to Neutral) and by Banc of America (from Buy to Neutral).
Pepsi Bottling downgraded by Deutsche Securities from Buy to Hold.
Pulte Homes downgraded by Banc of America from Neutral to Sell.
Baker Hughes upgraded by JP Morgan from Neutral to Overweight.
Cooper Cameron upgraded by JP Morgan from Neutral to Overweight.
MDC Holdings upgraded by Credit Suisse from Neutral to Outperform.
WebMD Health upgraded by Goldman Sachs from Sell to Neutral.
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