The Independent Investor: OPEC's Oil Ploy

Over the last four months, Americans have received an early Christmas present. The price of oil has dropped precipitously, benefiting both corporations as well as the consumer. But that could be a two-edged sword for this nation.

Brent crude, the global oil benchmark in the futures market, has declined 23 percent since its June price of $115 per barrel. Today it is trading below $83 per barrel, providing an enormous windfall in cost savings for all of us. The retail price of gasoline has dropped 15 percent during the same time period to a national average of $3.17 a gallon. Every one-cent decline in gas prices equals about a $1 billion drop in energy spending, according to economists. So we have all just received what amounts to a tax cut that has gone directly into our pockets.     

That's the good news. The bad news is that many of the same economists believe the reason prices have fallen so quickly is the deteriorating state of the global economy. Slower growth equals less demand for oil, all things being equal. As such we find ourselves with an oversupply of oil.

Now usually, OPEC, which controls the lion's share of oil production worldwide, would begin to throttle down the amount of oil produced per day. There would be meetings and all the disparate members of this energy cartel would decide what cut backs are necessary in order to prop up energy prices. This time around no such agreement is contemplated.

Instead, Saudi Arabia, the energy colossus, has been quietly telling the oil market that they would be quite comfortable with even lower prices for an extended period of time. Behind the scenes, they have said that $80 a barrel for a year or two would be just fine with them even though that level of pricing would hurt all OPEC members, and some more than others. Venezuela, for example, is in such bad shape that oil at that level would probably force the country into bankruptcy.

So what, you might ask, is the reason for this change in strategy? OPEC recognizes that a new competitor is emerging in the form of United States energy independence. Readers may be surprised to learn that the U.S. has emerged as the No. 1 oil producer in the world, even as it maintains the same spot in energy consumption. We can thank new technology, such as oil and gas fracking, for the turnabout in our energy prospects.

OPEC competitors would like to slow the rate of production here at home, thereby reducing our competitive edge. The best way to do that is by lowering prices. As prices drop certain sources of energy such as fracking and tar sands become less economical in comparison. Industry experts figure that a drop to $75 a barrel in oil would begin to curtail drillers and producers from developing additional fracking wells. The fracking industry has become much more cost sensitive since the early days of 2003. There has been so much capital sunk into the cost of expanding this output that any price change in oil impacts the bottom line much faster.

Investors are well aware of that risk, which explains why many energy stocks have dropped 25-30 percent over the last month. By keeping prices low for a year or two, OPEC could effectively gut much of the growth in energy production here at home. I suspect that is their game plan going forward.

There are other negative implications if OPEC succeeds in their plan. The U.S. oil and gas sector has added over 400,000 jobs since 2003. Some estimate that another 1 million to 2 million jobs have been created in construction, manufacturing and transportation to support our drive for energy independence. As a result, although the cost savings in energy consumption might contribute a 0.03 percent gain to GDP growth, the hit to Americas as a result of a decline in the energy sector could be far greater.     

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.