How To Profit As The Saudis Play “Chicken” With Oil

Oil prices are down since last week. Way down.

Looking ahead, though, I believe that we’re in the bottom of the price trough. Over the next six months, oil prices will likely head back up.

And the best part? This down-up price movement presents clear investment opportunities, which I’ll share with you in a moment.

First, though, let’s look at what’s happening in the trading pits…

Start With a Chart

Here’s the price chart for Brent Crude Oil over the past six months, showing prices heading down, down and down some more.

Oil Prices Down, Down, Down...

Six Reasons for the Price Slide

From over $112 per barrel in late June, Brent traded down to about $72 this month, a 35% tumble. What were key downward price drivers? Here are six elements.

  1. Traders’ perceptions of a slowdown in China economic growth, hence lower future demand.
  1. General global economic slowdown, from Europe (especially Germany) to the emerging world and even North America.
  1. Increased Russian exports to Asia via the new East Siberia-Pacific Ocean (ESPO) pipeline, creating price pressure for Middle East imports to the region.
  1. Growth in U.S. oil output via fracking, i.e. the “shale gale” and related tight oil boom.
  1. More refinery maintenance than usual this fall across the Northern Hemisphere, meaning less demand for crude oil to run through cracker units.
  1. And most importantly in the short term, Saudi Arabia has been discounting oil prices — especially in Asia, but also to U.S. customers — to maintain market share.Since last week’s OPEC meeting, they’ve forced the cartel to maintain production in a naked attempt to play chicken with North American tight oil producers, who have put the United States in the No. 1 oil producer slot, edging out the Saudis for the first time in decades.

In essence, we’re talking about “too much oil” for existing and perceived demand. Or as a wise old trader once told me, “There are just more people selling than buying.” Hence, prices fell.

Reasons Why Oil Prices Will Rise

Why should this current, low-price oil environment change? Or put another way, how low can oil prices go before turning around?

How low? Think back to the aftermath of the 2008 market crash. Oil prices fell off a cliff, from $147 per barrel in July, to $33 on one frosty morning in early 2009. So, could we see oil prices decline further, from $72 to a lower number? Hey, never say never.

Still, I believe we’re at or near the price-bottom. Here are six reasons why I believe things will begin to change soon.

  1. Outside the doors of OPEC meetings, there’s another price dynamic at work. Relatively low oil prices, of late, are playing havoc with national budgets of many oil exporting nations. Nigeria, for example requires about $130 per barrel to balance its national books (fat chance!), while Russia needs prices near $100 to pay all the bills. In general, there’s a global push, from many quarters, to find ways to increase oil prices. The current number, hovering around $70, is too low.
  1. Meanwhile, close to home winter is coming. That means it’s going to be… cold and snowy, and not just if you live in Buffalo, New York. Highly-credentialed weather-guessers are forecasting another frigid winter, with more polar vortexes just like last year. Energy demand will be strong in North America and Europe. Out in the field, expect harsh weather negatively to impact U.S.-Canadian oil output, by making it harder to operate in sub-zero conditions of oil patches from Bakken (North Dakota) to Marcellus (Pennsylvania) and more. Remember last year’s “vapor locks?” I do; long story.
  1. At the same time, across North America and other continents, refineries that scaled back for maintenance, this fall, are now coming back online. They need crude oil to flow through all those clean, shiny new pipes. This is positive for overall crude oil demand.
  1. Chinese economic growth will do whatever it does. Actually, according to no less than investment guru Jim Rogers, you can’t trust most economic statistics out of China anyhow. Still, I’ve seen hard numbers to the effect that China is using the current, low-price oil environment to fill its strategic petroleum reserve tanks, across the country. This oil doesn’t show up as “economic output” in Chinese statistics, but it makes for global-levels of demand just the same.
  1. Finally, I’ve heard from acquaintances up and down the supply chain that the falling oil price environment of the past six months has already caused a slowdown in scheduled drilling and completions in the North American oil patch. Thus, as 2015 kicks into play, I suspect we’ll see lower numbers of rigs, using less drill pipe, bits, services and more. It’ll lead to a slowdown in rising oil output from U.S. fracking, which will create its own price dynamic of perceptions.

What’s Investable?

I could discuss each of the foregoing ideas at length — why oil prices fall, and why they’ll rise again. In this note, however, I just want to lay them out for you. Now, let’s look at some investment angles.

Amidst oil pricing carnage, the offshore sector has recently traded down and transformed into one of the biggest bargains you can find. It’s risky, to be sure, but certainly at least a not-crazy contrarian play.

Transocean (RIG: NYSE) has been pummeled down to the $20 range, from over $50 earlier this year. Current yield is over 14%, although many traders expect a dividend cut. Still, here’s a strong company with a world-class fleet of deepwater rigs, and experienced crews. It’s hard to duplicate, and selling cheap.

Safer and sturdier, Oceaneering International (OII: NYSE) is trading in the $63 range, somewhat off its yearly high of over $80. I see limited downside here and solid gains if/when oil prices turn around. One great angle here is that oil companies that work offshore require OII products and services no matter what the oil price. You can’t just go idle with an offshore platform or other deepwater operation.

FMC Technologies (FTI: NYSE) has traded down to $47 in the low oil price environment, from a yearly high of $64. This one’s a gem of subsea tech, offering products and services that oil companies simply cannot find anywhere else. Oil prices may be high or low, but FTI has a strong business book, based on long-term capital investment requirements from across the global oil patch.

Take a look at Cameron International (CAM: NYSE) too. It’s trading near $50, off its yearly high of $74. In a rising oil price environment, CAM shares will recover well. Indeed, it would take an utter market crash to hurt the business book for a player like CAM.

In fact, considering the buyout frenzy of Halliburton (HAL: NYSE) and Baker Hughes (BHI: NYSE), vis a vis Schlumberger (SLB: NYSE).

That’s all for now.

Best wishes…

Byron King
for The Daily Reckoning

P.S. Ever wonder how you can make a lot of money from oil without owning a well? Or whether or not you should buy gold and silver? Or is fracking just a flash in the pan? Get insight, insider scoops and actionable investment tips twice a week with Daily Resource Hunter! Just click here for a FREE subscription!

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

This “old rock hound” uses his expertise and connections in global resource industries to bring...

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