Deflation [dih-fley-shuhn]
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Economics. a fall in the general price level or a contraction of credit and available money (opposed to inflation). Source: Dictionary.com
The US Energy Information Administration (EIA) published a very compelling chart last week; it shows that the net energy imports of the US as a share of consumption are at their lowest level in 29 years.
How can this be?
The reason is shale oil. The success of the shale oil sector—specifically horizontal drilling and fracking shale—has caused a significant increase in domestic US production. This is nothing new, and certainly isn’t a surprise to our subscribers.
But what is interesting was Saudi Arabia’s reaction to the increase in domestic US production. The United States had been Saudi Arabia’s largest oil customer… until the US Fed’s quantitative easing policy created cheap money, which fueled the shale revolution in the US.
Today, China is Saudi Arabia’s new best friend. The Saudis cut the spot price of oil to China and caused a significant whiplash in oil prices, which sent international oil markets from US$95 a barrel to below USD$85 a barrel.
According to the EIA, China is expected to surpass the US as the world’s largest oil importer by the end of 2014.
Saudi Arabia has taken an aggressive stance in slashing prices and maintaining its market share; and as a result, other oil producers will suffer, specifically ISIS.
Interestingly, there’s strong evidence suggesting that it is in fact Saudi Arabia which created the Frankenstein monster that is today’s ISIS. Let’s take a quick look back into the region’s history.
Saudi Arabia and Qatar have both funded Wahhabi Salafism under the guise of education. What is now ISIS originally took to the early teachings of Wahhabi Salafism, the goal of which is to convert Muslims and others to its “purer” form of Islam. In short, they’re extremists that make up less than 3% of the global Muslim population; this movement has been on the rise since 9/11.
Now I’ll put all the pieces of the puzzle together.
In the early days of the Syrian civil war, Saudi Arabian leaders were quite pleased with the initial Sunni fighters against Assad, but they weren’t happy when Russian President Vladimir Putin stood his ground and backed a longtime Russian ally in the Assad regime.
Saudi Arabia tried to sway Russia to turn its back on Assad’s regime in 2013, going so far as to dangle multibillion-dollar military contracts and other financial economic “incentives”… or what’s realistically known as a bribe.
Putin would have none of it.
He politely rejected the Saudis offer and stood his ground, with China in Russia’s corner.
Fast forward to mid-2014, and the Saudis have a Frankenstein on their hands. Its name is ISIS.
Yes, ISIS is a major oil exporter in the black market. If this sounds confusing, let me take you into the dark, back alleys of the Middle East oil trade.
“ISIS” stands for Islamic state of Iraq and the Levant. ISIS has been taking over oil-producing regions in Iraq and has been funding its military advances by selling oil on the black markets (specifically, in Turkey) at a discount, roughly 50,000 bopd. It’s the dark secret of the Middle East oil sector, but it’s happening.
ISIS first started selling smuggled Syrian oil in Turkey, making millions a day, but Obama doesn’t want that information widely known, so it was put on the down low. Politicians in Turkey have publicly stated that ISIS has sold US$800 million worth of stolen, black-market oil in Turkey alone.
ISIS then expanded into Iraq and has captured oil wells in Iraq—even the Russians have stated that ISIS has been selling “stolen” or captured oil from Iraq on the black markets. It’s much easier to sell stolen oil at a discount than oil that one produces.
So what can the Saudis do to take down their own Frankenstein?
The Saudis only nuclear-level weapon is oil.
Having realized that China had surpassed the US as their biggest oil buyer, the Saudis decided to start taking big discounts and continuing to pump oil to increase their market share in Asia.
Now the Saudis are attempting to hit four birds with one stone:
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Payback to Putin for supporting Assad’s regime in Syria (sub-$80 oil is bad for Russia’s GDP)
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Cripple ISIS—ISIS funds everything with black-market oil; so as oil becomes cheaper, there’s less money for the group
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Maintain market share—in the near term, the Saudis can absorb the lower costs (cheap conventional oil), and they definitely want to continue being the #1 supplier to China.
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Decrease US oil prices—perhaps even slow down US domestic oil production; that would result in the US importing more Saudi oil, and help fuel global growth with cheaper oil.
Don’t Mess with Putin: He Isn’t Your Regular Politician
Russia isn’t cutting back its production—rather, Russia is hitting post-Soviet highs in oil production. Thus we see tumbling oil prices.
But how low can this go? Let’s get back to basics of supply and demand to answer this question.
In the last 35 years, world oil consumption growth has gone into negative growth (meaning below zero growth—meaning world uses less oil) only twice.
The first was the 1980s recession; the second instance was the global financial crisis of late 2008.
But during both times, the US was without a doubt the world’s largest consumer and importer of oil. Essentially, the world consumption of oil is directly and positively correlated with the real US GDP. In fact, the correlation is +0.99, which is about as good as it gets when it comes to correlation coefficients.
However, horizontal drilling and fracking has increased US domestic oil production, and as a result, US net imports as a share of consumption are at their lowest level in 29 years.
Over the last 35 years, China has awakened and has become a game changer in the global energy markets. It will continue to play that role. According to the EIA, China is well on its way to becoming the world’s largest importer of oil.
China consumes about 11 million bopd—and it’s expected to match US consumption by 2030.
However, the growth of the US domestic oil production from shale oil is not cheap oil production… and shale oil comes with a high decline in production.
What Happens to US Domestic Oil Production at $75 Oil?
On average, an Eagle Ford or Bakken shale oil well needs US$55-$70 oil to make a decent profit, in order to continue drilling to replace the decline rates of existing shale oil wells. Many other shale oil formations need higher than $70 oil to break even. Thus, we can expect the incredible growth of domestic US oil production (primarily as a result of the Bakken in North Dakota and Eagle Ford in Texas) to become significantly impacted at prices below $75. This means lower domestic oil production rates, which then means importing more oil from either Canada or the Middle East.
However, Canadian oil isn’t any cheaper to produce than American oil; therefore, one can expect Canadian oil growth to also start declining at $75 oil. The only blessing for Canadian producers in this scenario is a weaker Canadian dollar.
This is all good news for the informed and prepared energy investor.
In the September Casey Energy Report, we broke down all of the US oil producers and compared them to the Canadian oil producers, explaining the fundamental differences between the two. We’ve broken down all of the metrics company by company, and have our Buy list ready.
In that report we stated that we would rather be patient than rush into a volatile sector. This month, we presented our first of three stocks that you must own in a declining oil market. These stocks will not only pay you an incredible yield, but each is the best company in its peer group in terms of metrics such as payout ratios, lowest-cost producer, and low debt.
We’re excited about the market selling off and have been using $75 oil and $3 natural gas in our calculations. We’ve also stress tested every producer on both the US and Canadian stock exchanges and have our full analysis ready. In this month’s Casey Energy Report, we’ll explain to subscribers how to best position their portfolios to reap the rewards of a $75 oil price.
And now, a personal note to all my readers.
Over the last decade, I’ve traveled the world over trying to find the best resource investments. Some have worked out spectacularly well while others have failed, and others are still in the works. Doug Casey wanted me to write a book a few years ago, but I don’t see myself as a writer, but rather as an analyst and speculator.
However, after my personal health challenges (which I’m proud to say I have under control), I thought I may want to get to my bucket list sooner than later, and the time was right for my first book.
Its subject?
The Colder War.
The book covers many aspects of the geopolitics of energy… especially the struggle between Russia and the US to control the world’s energy trade.
Some pretty influential people have endorsed my book, such as former Congressman Dr. Ron Paul, who stated:
The Colder War provides a reversing contrast from the hysterical "Putin is Stalin, Jr., restart the Cold War" message emanating from the neocon think tanks and the mainstream media. Marin Katusa shows the real threat to the American people …
You see, while America and the West weren’t looking, Vladimir Putin has been orchestrating a takeover of the energy sector.
He has transformed Russia from a crumbling former Soviet state into an energy powerhouse to become:
The second-largest oil exporter in the world, on pace to pass Saudi Arabia very soon;
The largest uranium exporter in the world, powering 1 in 10 American homes;
The largest natural gas exporter in the world, doling it out with an iron fist and willing to cut off supply and let harsh winters kill thousands to get its way.
Russia is quickly becoming the only source for countries desperate to secure long-term supplies of energy—giving Putin more power and more leverage than ever before.
Europe, Africa, and China are all dependent on Russian energy. And Putin won’t stop until he takes down the only thing standing in his way of turning Russia into a superpower: the US.
Inside my book, you’ll discover that Putin is working to break the monopoly of the US dollar in the global energy trade. He’s set in motion in an ingenious yet devastating plan to do it.
If Putin is successful, he could nuke the US economy and cost the average American dearly.
Do you think the recent pullback in oil prices will cripple Putin? If you said yes, you’re wrong… and you really need to read my book.
Friends and colleagues have told me that they’ve sat down and read it in the course of an evening. It’s that fascinating and easy to digest.
Once you read it, your view of the world and the global markets will change.
You might even want to call your broker the next morning—because the US has never been more vulnerable, and the stakes have never been higher…
Preorder your copy of The Colder War and make sure you’re among the first to read this important book.
Sincerely,
Marin Katusa
Chief Energy Investment Strategist
Casey Research
