Oil and Gas

Crude Oil Prices Tank Thanks to Global Overproduction

Do you have shares of an independent oil producer in your portfolio? You may want to edge your pointer a little closer to the “Sell” button…

Last Friday, oil prices had their biggest monthly decline in six months. This happened after President Trump threatened Mexico with import tariffs.

WTI crude fell as low as $53.41 per barrel. That was its weakest showing since February 14.

Brent crude saw its futures fall 3.6%, and it traded as low as $64.37 per barrel. That was its lowest point since March 8.

So, besides our tiff with Mexico, what’s affecting oil prices these days? It might be easier to show you what isn’t.

A Global Glut

There are a number of geopolitical factors at work here.

Let’s start with Libya. It’s currently pumping 1 million barrels per day (bpd).

Mustafa Sanalla, chairman of Libya’s National Oil Corporation, has $60 billion worth of contracts he wants to give to willing upstream exploration and production companies.

The country is in a fragile state at the moment. Nonetheless, it wants to increase crude production to 2.1 million bpd by 2023.

This past April, Nigerian crude output reached a 14-month high of 1.95 million bpd. The country’s OPEC quota is only 1.69 million bpd, but it’s a consistent overproducer.

Also in April, Petrobras (NYSE: PBR), the national oil company of Brazil, set a new monthly production record of 1.94 million bpd.

By 2025, Brazil expects its production to hit 5 million bpd. This would make Petrobras one of the top five global crude producers.

Then there’s the ongoing U.S.-China trade war. Like everyone else, I have no idea what Trump’s endgame is here.

A global recession is a distinct possibility if our trade war with China drags on. That would be a bearish sign for oil prices.

Lastly, let’s not forget about U.S. shale production.

In March, U.S. production was 11.9 million bpd.

The U.S. Energy Information Administration is forecasting that global crude supply will increase by 1.9 million bpd in 2020. And 1.5 million bpd of that will come from the U.S.

Oil’s Natural Selection

It looks like we’ll have a massive oversupply. What could happen to change that?

My friend Rick Rule, president and CEO of Sprott U.S. Holdings, has been in the natural resources securities investing business for more years than he cares to admit. And he has a truism when it comes to prices: “The cure for high prices is high prices, and the cure for low prices is low prices.”

If prices stay too low for too long, it will force some producers out of the business. And that could happen in the next six to 12 months.

Shale companies have increased lateral length, reduced well drilling and completion time, and implemented other technological advantages. Alas, most are still unprofitable.

Nine out of 10 are burning lots of cash. Out of 40 companies studied by Rystad Energy, only four reported a positive cash flow balance for the first quarter of 2019.

And there are other signs too. Small drillers are seeing their capital dry up.

Larger producers like Occidental Petroleum Corp. (NYSE: OXY) are betting the farm and borrowing big to keep production rolling. Occidental quadrupled its debt to $40 billion.

The Real Threat

Perhaps the biggest threat to oil companies is renewable energy.

The costs of various renewables continue to fall.

Here’s the proof… More than 75% of the onshore wind and 80% of the solar photovoltaic capacity that is expected to come online in 2020 will produce energy at lower prices than coal, oil or natural gas.

So it’s not a bright scenario for oil investors. Just about any other sector will be a better investment over the next few years.

Have a different opinion? I’d like to hear it. Leave a comment below.

Good investing,

Dave