OPEC's Proxy Wars

Written By Christian DeHaemer

Posted August 28, 2014

The oil price just broke down…

Take a look at this chart of West Texas Intermediate. For the past five years, we’ve been riding an uptrend.

This week, the price of oil broke below that trend line. That is a bearish sign for oil prices.

op1

In this article, I am going to tell you why the oil price is falling, how far it will go, and how you can profit from it.

More Supply from the U.S.

It isn’t quite a secret that the U.S. is pumping mad oil. We are now riding at the top end of the five-year range of oil supply.

fiveyearsupply

This week, supplies in Cushing, OK rose by 500,000 barrels to 20.7 million barrels. Cushing is the physical delivery point for the NYMEX contract, and WTI is more and more sensitive to the Cushing supply levels.

Both Brent and WTI have fallen by more than 10% since mid-June and remain on track to post a second monthly fall as China is slowing down, Europe is facing another recession, and U.S. oil imports are falling.

OPEC Civil War

On top of all of this, the Middle East is in a real shooting war between Sunnis and Shias — that is, Iran is fighting Saudi Arabia, with proxy wars in Iraq and Syria.

It’s no wonder there is little cooperation in OPEC, as seen by a public fight at June’s OPEC meeting.

Countries like Iran, Tunisia, and Libya want to reduce supplies and jack up the oil price so they can pay for their deteriorating economies before the peasants break out the pitchforks. The WSJ reported that Iran needs Brent prices at $105 to cover its societal costs.

Don’t forget that the Middle Eastern revolutions of the past three years were based on food inflation. People will put up with almost anything before they overthrow a government, but they will not let their children starve. The Arab Spring was trigged by a Tunisian food vendor over the high prices of food.

On the other side the argument is Saudi Arabia, who understands price elasticity of demand. It wants to pump more oil to bring down prices.

The Saudis have been the controlling power of oil prices for the past 40 years. They know that continued high prices will cause consumers to seek out other forms of energy, meaning they will lose market share. Since the price of oil hit a $12 low in 2000, the Saudis have been very adept and successful at playing the oil price game.

And yet, due to the wonders of capitalism, OPEC lost market share anyway. As you can see by this chart, OPEC oil output has been flat since 2004, while non-OPEC oil continues to grow.

marketshare

The bottom line is that since the June OPEC meeting, the Saudis have been pumping more oil. The Joint Oil Data Initiative puts the estimated average for 2014 at 9.7 million barrels a day versus a previously estimated 9.4 mbpd.

Crudely Speaking

Looking to the future, there are bullish production scenarios in North America. The U.S. Bureau of Energy Management has announced that the government will allow seismic analysis on the Outer Continental Shelf off of the Atlantic Coast. This has been banned since 1983.

In other news, Mexico is opening up its oil industry to outsiders. These two factors won’t impact oil production this year or next, but they bode well for cheaper oil prices in the future.

Two ways to play the bet on lower oil prices are the ProShares UltraShort DJ-UBS Crude Oil ETF (NYSE: SCO) and the PowerShares DB Crude Oil Double Short ETN (NYSE: DTO).

In terms of timing, both of these ETFs are overextended and are trading at the tops of their short-term ranges. I do like them on the dip, and I’d be a buyer of DTO under $32.25. I like SCO under $28.

All the best,

Christian DeHaemer Signature

Christian DeHaemer

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Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.

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