If there is any derivative worth talking about today, it surely is oil price. What a stellar performance yesterday for both Crude and Brent and both of them are on track to to continue their gains this morning. It has been a very long time that we came across any headlines which says that crude oil is up 10 percent- really 10 percent!
The first thought which comes to your mind after reading a headline like this is that perhaps, OPEC has finally decided to give up and accepted the US shale oil industry as a major player. Hence, they have announced a massive cut in their production, which is boosting the price. Alternatively, have the U.S. Shale oil producers gave up and cannot take any more lower oil price in the face of coming rate hike and decided to put their rigs in a history museum. One final scenario could also be that yes, all of a sudden we have a massive surge in demand which is outpacing the current supply.
Unfortunately, it wasn’t any of the above and the rally was still this strong. It begs the question what was the factor which has pushed the price so high then? Well, it was only the U.S. GDP revision data which lifted the price higher and traders have finally realized that how cheap oil has been. Then there were also rumours, which in fact have been brewing up for the past few days that OPEC countries will hold an emergency meeting to address the supply concern.
Supply is the most significant factor which has brought the rout in oil prices and it is this part of the equation which traders need to pay more attention. The fact which cannot be denied at any angle is that OPEC countries are producing more oil than they initially planned and this is because they are fighting for their market share. The current output by OPEC is nearly 31.5, well above their agreed limit and Saudi Arabia is taking the lead in producing more oil. Lower oil price has made them to pump more oil so that they can not only meet their expenses but also maintain their market share.
Russia has suffered enormously due to the lower oil price and the country finally removed their dollar peg while back and now pumping most amount of oil with the production of 10.6 million B/D. It desperately needs cash and the only way to satisfy this craving desire is to pump more. But, then the question is, if Saudi Arabia not feel guilty in driving the prices this lower. No, they certainly not, because the country warned other members back in 2011 about the upcoming U.S. Shale oil threat, but unfortunately one came on board to battle this storm. Now that we are facing this supply glut, they do not have a soft spot for other players and their ultimate desire is to rubber stamp the investor approval that they are the only reliable source of production.
Saudi Arabia is still maintaining its currency peg and unlike Russia and Kazakistan they have not free floated their currency, which gives them even more room to drive the production high if necessary. What they did previously was that they miss estimate the production cost for the U.S. Oil producers and thought their cost is around the 60 mark, but now they are well aware of their mistake and the break even cost, which is near enough the 29 dollar mark. What the country wants this time to permanently disable the U.S. Shale oil production by keeping the supply high and use a combination of tactics to face the headwinds. The country is seeking advice on its budget and it is planning to cut investment spending by 102 billion dollars this year and augment this figure by another 10 percent by next year.
The possibility of Iran occupying its 2nd place amid OPEC countries and ramp up its production has also not only impacted the price of oil, but it has also aided Saudi Arabia’s mission to drive US shale oil producers out of their comfort zone. Producer need half a trillion dollar to repay their debt and 550 billion dollar of debt is due within the next five years. Not to mention, that increase in the U.S. interest rate will make matters only a lot worse than many are anticipating today. If you look at the U.S. Shale oil companies, nearly 30/62 have produced higher revenues due to their hedging technique. They hedged their future price a lot more higher as the derivative contracts in the first half did not really priced in lower prices which can last for prolong period of time. The ratio of debt to earning is only increasing for US energy firms and if the prices stay at these lower levels this can only become worse and the U.S. shale oil producers will not be able to borrow any more or extend their maturities. It is then, we will face massive takeovers.
Nonetheless, for now, bargain hunters have bought the black gold as it appears to be way too much cheap. The price below the 40 dollar brought many speculators in the market. So far the news of OPEC holding an emergency meeting is nothing but a rumor and if this turn out to be true, we could see another leg of the upward move for the oil price.