Crude dropped for the second straight day yesterday (Tuesday) after Saudi Arabia made it clear that the Organization of the Petroleum Exporting Countries (OPEC) will leave its production targets unchanged at its meeting tomorrow (Thursday).
Crude oil for November delivery fell 54 cents a barrel – or 0.7% – to finish at $81.67 a barrel on the New York Mercantile Exchange yesterday. Even with yesterday’s decline, oil prices are up 11% over the past 12 months.
Speaking in advance of tomorrow’s OPEC meeting in Vienna, Saudi Oil Minister Ali al-Naimi said that prices between $70 and $80 a barrel are “ideal,” and noted that the market is “very well-balanced” right now. In a related development, Sanford C. Bernstein & Co. LLC slashed its oil-price forecasts for both next year and 2012, and attributed the new viewpoint to big stockpiles.
But this only provides you with part of the picture. And it’ll lead you to the wrong conclusions.
So here’s the proverbial “rest of the story” – including everything you need to know about tomorrow’s OPEC meeting.
What OPEC is Really Thinking
OPEC wants to keep the price of oil below $100 a barrel. Above that level there is genuine concern that the price will discourage the global economic recovery and thereby create problems for oil sales. But that’s the Catch 22 quandary OPEC isn’t talking about: Once the global economy revs up, this genie gets out of the bottle and futures contracts will send oil prices well above the $70 to $90-a-barrel price range that the cartel prefers.
In other words, lower prices now guarantee higher prices later. That’s the insight we’re going to profit from.
Wilson Pastor is Ecuador’s minister for non-renewable natural resources, and a very capable fellow. We have worked together on the refinery project I advise down there. In capital city Quito, given the country’s declining oil production, prospects for the global market are very important.
Well, Ecuador also happens to be one of the 12 members of OPEC, the Organization of Petroleum Exporting Countries. And Wilson just happens to be OPEC’s new president.
As it celebrates its 50th birthday, the oil cartel is demonstrating some of the strains developing in the oil market. Still, it can sometimes be very subtle in its reading of the oncoming situation.
What Wilson says has an impact on your investment plans in energy.
However, unlike market misgivings in the past, this has less to do with fears that OPEC might cut production, and more to do with what the cartel sees for the global market moving forward.
The main conclusion is pointing in a very different direction.
OPEC’s Stealth Move
In recent weeks, attention once again turned to tomorrow’s OPEC meeting in Vienna – and the usual uncertainties from TV’s talking heads over whether the cartel will cut production.
The really important move, on the other hand, has gone almost unnoticed.
In terms of tomorrow’s meeting, we’ve been telling Energy Advantage readers for weeks that there was no chance that OPEC would change its production quotas at that meeting – or, for that matter, at the special meeting set to take place in Quito in December. All of OPEC’s projections point toward the price of crude remaining between $75 and $85 a barrel for the rest of this year.
That means that the cartel can effectively balance production and return without resorting to market manipulation.
OPEC has left its output ceiling unchanged for almost two years: In December 2008, the group announced a record supply curb of 2.2 million barrels per day to combat lower demand and prices. That is hardly likely to change this time around.
Anyway, OPEC has not actually tried to directly dictate prices for some time. Rather, it relies on careful prognosis of demand levels and then attempts to set its production accordingly.
The cartel estimates what it will pump by first estimating worldwide demand, then forecasting non-OPEC extractions, and, finally, by subtracting the second from the first and establishing what is called the “call on OPEC.”
Lastly, OPEC determines production quotas for each of the 12 member nations.
Those quotas are voluntary, and overproduction has occurred. However, the countries have learned (sometimes the hard way) that consistently ignoring the quota will risk bringing additional Saudi production into the market as enforcement, thereby driving down the price (as occurred in the mid-1980s).
Compliance is now running at about 53%, indicating that some of the members are choosing to exceed their production allotments. The reason: They are still running budget deficits from the depressed prices that held sway during the financial crisis and are trying to make up lost ground.
OPEC officials are now publicly saying that greater adherence to the quotas is necessary to maintain the organization’s overall position – a clear sign of growing concerns over its members maintaining a common approach.
There are grounds for such concerns. Because the real news has been almost buried.
Surprise! Demand is Actually … Rising
OPEC has quietly increased its overall global demand projection for 2011. And for the first time in three years, it also raised the forecast for its own supply requirements to meet that demand.
With a greater amount of the global daily oil coming from non-OPEC sources, the organization cannot dictate market direction, as it did in the past. Yet controlling 40% of the total still gives it the greatest clout.
The increase – 1.2% – may not sound like much at first. But that boost indicates that expected worldwide daily demand has increased to 86.4 million barrels. And there are indications now emerging that, before long, this projection may need to be increased again.
The translation: The cartel sees demand coming back and prices going up.
Now the official line – for example, in yesterday’s statement by al-Naimi, the Saudi oil minister – would have us believe that supply and demand are “very well balanced” and that current prices in the $80 range should hold. Yet government contacts in members Kuwait and the United Arab Emirates are privately estimating prices well north of $100 by this time next year. And some at the OPEC Secretariat (the cartel’s administrative arm at the headquarters in Vienna) are planning for rises more quickly and to higher levels.
The logic is straightforward.
Whether you adopt a figure of $80 or one well in excess of $100, there is now a consensus inside OPEC that overall global demand is returning.
That will drive up the price of oil without OPEC having to do a thing.
Some members – Venezuela and Iran, for example – would like to see that price increase as quickly as possible. Venezuela’s Oil Minister Rafael Ramirez said on Sept. 14 that $100 is now a justified price.
Saudi Arabia, on the other hand, usually takes a more cautious approach. Capital city Riyadh believes that a persistently high price will prompt greater U.S. and European interest in alternative energies while at the same time increasing the risk of government intervention in importing countries – two developments that would cut into OPEC sales.
But the force propelling the rise is no longer coming from the developed counties – usually referred to as the OECD states. This is the Organization for Economic Cooperation and Development, creator of the Paris-based International Energy Agency (IEA) and an organization that was established to counter OPEC.
This spike in energy demand has already returned in Asia and Africa, leading to upward revisions in both OPEC and IEA figures.
OPEC projections now acknowledge that the economic recoveries are also under way in both North America and Western Europe. And that means the traditional markets for oil will also be increasing. Ecuador’s Pastor advises that the instability in the market will be increasing and the overall price levels along with it.
As a result, Pastor does not see any plans to change OPEC output quotas. The market dynamics will establish a price floor in the current range of $75 to $85 a barrel, with upward pressure moving in going forward.
And that means the strategy we are setting out is square on.
Remember, the rise in futures contracts (the “paper” barrels) will occur in advance of a spike in market prices for the actual crude (the “wet” barrels). [Note: For a more-detailed explanation of this relationship, read about the oil-futures bubble in “How the Little Guy Will Fix Oil Futures,” which appeared in my Oil & Energy Investor newsletter back in March.]
In short, all the forward indicators are pointing toward a rise in prices. The only question is this: How quickly will we see the increase in full-blown demand?
Ecuador’s Pastor and OPEC are merely the latest market movers to tell us this.
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Actions to Take: We’ve been telling our readers – both here in Money Morning and in our affiliated publications – for some time that we believe oil prices would ultimately head higher.
And investors could well see some of the catalysts start to come together this week – a busy one for energy investors. With the close at $81.67 yesterday, crude for November delivery is down about 3% from the five-month high of $84.43 it reached last week. Brent crude for November settlement on London’s ICE Futures Europe exchange fell 22 cents, or 0.3 percent, to $83.50 a barrel.
The U.S. Department of Energy is scheduled to release last week’s petroleum data in Washington at 11 a.m. tomorrow (Thursday). That’s a day later than usual because of yesterday’s Columbus Day holiday.
The industry-funded American Petroleum Institute will report its numbers today (Wednesday).
With demand on the increase, oil prices are clearly headed higher – despite what other energy-sector mavens would have investors believe.
Here’s how we respond.
Given our belief that prices will rise, the objective is twofold:
- Assemble a portfolio containing the stocks of individual companies in the extracting, field-service, and processing segments of several different portions of the global energy sector.
- At the same time, look to deploy exchange-traded funds (ETFs) and exchange-traded notes (ETNs) that will benefit from the advancing price of oil and other energy sources.
- For investors seeking more-detailed guidance on specific stocks, ETFs and ETNs that will benefit from the trends we’ve detailed here, consider The Energy Advantage, the advisory service run by Dr. Moors.
[Editor’s Note: Dr. Kent Moors, a regular contributor to Money Morning, is the editor of “The Oil & Energy Investor,” a newsletter for individual investors. In a career that spans 31 years, Dr. Moors has been consulting the energy industry’s biggest players, including six of the world’s Top 10 oil companies and the leading natural gas producers throughout Russia, the Caspian Basin, the Persian Gulf and North Africa.
As the preceding story demonstrates, Dr. Moors’ experiences – as well as the unrivaled industry access, contacts and insights he possesses – are the backbone of The Energy Advantage, an energy-sector advisory service that enables investors to capitalize on his contacts and his global-energy-sector insights. For more information on that service, please click here.]