In this blog, I am going to talk about oil prices and where oil prices are headed.
There is much speculation as to the direction of oil prices and what the next move of the OPEC cartel will be. If you are a resident of the province of Alberta, there is an eager anticipation for the price of oil to go back up, or at least reach the level it was back in the early part of 2014, before the oil prices came crashing down.
Much emphasis has been placed on OPEC, as though they dictate the direction of oil prices. The reality is that the OPEC members only supply about one third of the total global oil market. Every time we hear the word OPEC, we think of Saudi Arabia as the world's top oil producer and leader of the organization. In reality, it is Russia and not Saudi Arabia who are the top oil producer and the USA is a not-too-distant third as a top oil-producing country of 2016. Both Russia and the USA are not OPEC members, which means that all the oil-producing countries affiliated with OPEC have very little influence over how much oil is produced by non-members, given the amount of oil produced by Russia and the USA.
Furthermore, after the financial crisis of 2008/2009 the U.S. invested heavily into the development of a new oil extraction technology known as fracking. With fracking, the USA can tap into their huge oil reserves. It was stated that at the rate that these new fracking oil fields were being developed, the USA would become a net oil exporter by the year 2020. Keep in mind that prior to fracking technology, the USA was importing roughly 10 million barrels per day, which equates to about half of their daily consumption. With fracking technology, in just 10 short years the U.S. was set to become self sufficient and would produce enough oil to export to other countries.
As you can imagine, the Saudis did not receive this news well, with the prospect of losing their biggest client. In order to rebalance the market, they decided to bankrupt all of the oil-producing fracking companies. They estimated that the cost of producing one barrel of oil by fracking would cost $58 per barrel. As long as they were able to keep oil below this cost, fracking would become unsustainable. In a short interview, the Saudi minister of energy clearly stated that "they are flooding the oil market to keep prices below $58.00 to stop the development of the oil fields using fracking technology."
They succeeded in bringing the prices down, but they failed to consider the full spectrum of unintended consequences. They failed to consider that by bringing down the oil prices, other countries that rely on the revenue generated by the sale of oil and oil-related products would not be able to balance their budgets, forcing them to over produce in order to compensate for their budget deficit.
So, where are the oil prices heading? The short answer is nowhere. If nothing in the oil market changes, there is no reason for oil prices to change. There are two main reasons for oil prices to move in the global market, "supply and demand." Let's just focus on these two main points.
The fundamental issue affecting global oil prices is oversupply. Currently there is an oversupply of about 1.5 million barrels of oil a day, and unless this problem is corrected, oil prices are going nowhere.
How can the issue of oversupply be corrected?
I suppose one way would be to create a new market that absorbs 1.5 million barrels of oil a day. Although it is possible, it will be a while and will take sometime, maybe even years, to develop such a market especially when the market is saturated and oil storage facilities are full to the brim.
Another way will be to make an agreement with OPEC and non-OPEC members to voluntarily reduce production. This would be a little more difficult because self-interests play a large role in the oil market. Not to mention that there is strong animosity even within OPEC members who will not agree to a permanent oil output reduction due to fears of losing market share on the global stage. For this to happen, the financial pain will have to be so intense that all oil producing countries will have to put their differences aside and be willing to work together, to agree to a reduction in daily output while a new market is being developed.
However, even if they succeed in agreeing to an output reduction and prices end up moving above $58 per barrel, oil fracking wells will be reactivate, causing oil prices to fall once again.
There must be an agreement between all oil-producing countries to curtail production, otherwise the price of oil will remain stagnant.
The Alberta oil industry has been negatively affected by low oil prices and there have been massive layoffs in the oil sector. Construction and housing has been slowed down for the last couple of years. But now we are beginning to see signs of a real-estate market recovery, but this recovery is different. It seems that foreign investment and industry diversification in the province are the driving forces in the new real-estate market recovery, and are no longer dependent on high oil prices.
Joaquin Benitez is a licensed real estate agent and author of the book, The Foreclosure Phenomenon: How to Defend Your Home from an Impending Foreclosure, available at Amazon.com and chapters.indigo.ca
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