OPEC Cuts Off Its Nose To Spite The Face Of U.S. Shale Boom

This article was originally published on on December 1st at 12:00pm EDT

Despite the fact that oil’s precipitous decline began five months ago, it is only now that it is really front and center. At this point we all know that Organization of Petroleum Exporting Countries (OPEC) leaders met on Thanksgiving Day and agreed not to cut production (from the current 30 million barrel per day level). But with oil down 40% in less than six months, investors and consumers are wondering what’s going on, and how long it’s likely to persist.

WTI closed Friday’s session at $68.

Down 10%

Three months ago it was suspected that — since oil is denominated in U.S. dollars — strength in the dollar was putting downward pressure on oil prices. The price of West Texas Intermediate (WTI) crude was 10% off its July high of $107 per barrel at this point.

Down 20%

Two months ago the most likely culprit seemed to be weakening global economic growth (deflation), and, therefore, weakening demand for the world’s most used and watched commodity. You couldn’t find a financial website without concerns of a European recession and slowing Chinese growth smattered all over its homepage.

Down 30%

One month ago, with oil 30% below its most recent peak, it looked like there must be additional forces at work. It was suggested that perhaps the OPEC nations — and Saudi Arabia in particular — were launching a sort of “oversupply attack” on their newfound competition from U.S. shale production. By flooding the market with more oil than necessary, the Saudis have been able to manipulate the worldwide price down to levels where it is not profitable for many producers to explore, drill, and refine. Smaller, newer producers in particular. With the U.S. now generating 9 million barrels per day, the reasoning is obvious.

Down 40%

As of Friday’s close, a barrel of oil costs 40% less than it did just five months ago. And at this point it seems clear that the OPEC member countries are extremely concerned about the rapid growth of U.S. shale production. So much so that they are willing to adopt Amazon’s (AMZN) philosophy — foregoing profitability for the time being in the hopes of reducing competition.

Who are the winners?

The consumer and consumer discretionary names are the obvious beneficiaries of cheaper oil. Lower prices at the pump means more dollars left over after fixed expenses. Stretched consumers may not need to think as hard about taking that road trip, buying that one extra gift, shopping at Whole Foods (WFM) instead of the traditional supermarket, or treating themselves to a nice dinner.

Stocks that potentially benefit are in all the places where that extra money gets spent — think J.C. Penney (JCP), Macy’s (M), Whole Foods and Darden Restaurants (DRI). In addition, the airlines instantly become more profitable — look at Delta Air Lines (DAL), Southwest Airlines (LUV), and United Continental Holdings (UAL).

If you believe this trend is likely to continue, you could also choose from one or some of the following ETFs: iShares Global Consumer Discretionary (RXI), iShares US Consumer Goods (IYK), SPDR S&P Retail ETF (XRT), Vanguard Consumer Discretionary (VCR) and/or the iShares Transportation Average (IYT).

And the losers?

Lower oil prices mean lower profit expectations for drillers and refiners, not to mention anybody selling services to drillers and refiners. As a result, we’ve seen some pretty severe destruction in names such as Chevron (CVX), ConocoPhillips (COP), ExxonMobil (XOM) and the index in which these are three of the largest holdings — the Energy Select Sector SPDR ETF (XLE)This index fund is down 20% from its recent high of $100 in early July.

XLE was at this level a month ago, and at $80, the fund’s annual yield is now at 2.23%. That’s better than the 10-year U.S. Treasury Note today, at 2.20% as of this writing.

Other likely losers include, but are not limited to, the major oil-exporting nations. That means Russia (40% of its GDP is tied directly to oil and natural gas exports) and nearly all of the OPEC members, especially Saudi Arabia (responsible for 9.6mm of OPEC’s 30mm barrels daily). You can find details on OPEC production figures and trends on page 54 of their most recent report here.

The fact is, Saudi Arabia is losing money with oil prices at current levels. According to the chart below from Citigroup, any price below $98 per barrel makes the Saudis’ largest export a loser.

Conversely, the majority of U.S. shale projects will still break even all the way down to $70 per barrel.

How long can Saudi Arabia tolerate losses on this level? I don’t know, but there is an enormous amount of pressure building. It seems the Saudis are concerned enough about their prospective loss of market share to play Russian roulette with the rest of the world.

Since this is unlikely to resolve itself in the very near term, you may want to consider taking strategic tax losses in energy-related names with the intent of re-entering in the new year.

If you have questions or would like to engage in a dialogue, please don’t hesitate to give us a call.

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on RealMoney can be found here.

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