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Are the Saudis Killing Cheap Oil?

Murphy’s law — that which can go wrong, will — is about to bite Saudi Arabia in the butt … and you and me in the wallet.

The country’s decision to let oil prices collapse as a way to maintain market share is already causing big problems in the oily kingdom. There are rising concerns, even inside the country’s central bank, that the Saudi government faces an existential threat to its existence in the very near future.

It’s already leading to global problems that absolutely will tear through the oil market of the future. And that’s where the problems for my wallet and yours begin…

Lately, I have been tracking oil project cancellations because of the collapse in oil prices.

So far there are at least 46 projects that major energy exploration companies around the world have cancelled. Russia, the Gulf of Mexico, deepwater ocean projects, Canada, Asia, South America — all have seen projects killed.

Total value: more than $200 billion.

Total oil production bypassed: in excess of 20 billion barrels of reserves, which, if all those barrels were in one country, would place it among the 15 largest reserves in the world.

That has future effects. Very, very meaningful future effects.

They are the same effects that happened a quarter-century ago, when oil prices had fallen into the teens. Exploration companies saw no reason to hunt for new reserves because the market price didn’t justify the expense.

And yet all the while, existing reserves were dwindling with each barrel of oil produced, and demand was growing as the world economy continued to expand.

The upshot: Oil-production companies reached a point where available supply at existing prices could not meet demand, and, thus, oil prices shot to the moon, racing over a few short years to more than $140 a barrel from just $20.

Though we’re now 25 years further along, the cause-and-effect relationship that resulted in $140 oil has not changed.

The Saudi decision to allow oil prices to collapse is the proximate cause of the decisions globally to cut $200 billion from exploration budgets. All the while, however, existing reserves will continue dwindling with each barrel of oil produced, and demand continues to grow — as OPEC, the International Energy Agency and American Energy Information Agency all expect.

The effect will be exactly as the world experienced last go-round: Production companies will reach a point where their available supply at existing prices will be incapable of meeting demand that continues to grow as the global economy expands. (Green tech will eat into some of that demand, but not enough to radically reduce oil consumption in the near- to mid-term, which is when the oil-price shock will happen.)

Because the Saudis either miscalculated, or never learned about Murphy’s law, the world is now set up for an oil-price spike.

And it could be even worse because of the way the Saudis have screwed themselves…

The Saudis Have Shot Themselves

For all its oil wealth, Saudi Arabia is a financially rickety joint.

It is wholly dependent on oil revenues. And if that just meant being dependent on oil for running the water department and city hall that would be one thing. You just cut back spending on nonessential services and personnel, and impose some taxes and user fees to cover the cash crunch.

But when your budget must cover social spending costs in order to keep a very restless population from revolting … well, you’ve reached a whole new level of “screwed.”

The Saudi government is not well-loved. It’s largely disliked and, in many cases, deeply despised at home. It buys peace through heavy spending on social items such as housing and fuel subsidies. It is also spending heavily on infrastructure and on foreign policy in the Middle East to shape the fight between Sunni Muslims (the Saudis support the most extreme brand of Sunniism) and Shia (largely Iranians).

That’s a pricey proposition. The Saudis are draining their national treasury quickly. By some estimates, the country could deplete its cash reserves within a year, maybe two. And then what? How do you buy the peace when you have no money?

Does Saudi Arabia devolve into a battlefield? Does a weakened Saudi government give ISIS or other terrorist groups an easier perch in the country that’s home to Islam’s holiest sites (which is ISIS’ goal)?

It’s a massive risk to the global economy, as I first laid out in the January issue of the monthly Sovereign Investor … and it’s a risk that the Economist Intelligence Unit (which gauges industry and country risk across the world) now calls one of the top five risks globally today.

Oil’s Next Stop

Oil prices would reach levels that no one today is willing to guess at. $200, maybe $250 a barrel? $500 on an emotional shock that sends investors into paroxysms of panic? Impossible to say the exact level. But it’s not impossible to see a scenario that leads us down this path to higher prices.

That scenario is already playing out.

Now is the time to own energy stocks such as exploration companies, major production companies and oilfield-services companies. They are cheap. Dirt cheap in many cases. And the time to own them is when sentiment is low and risk high.

That’s right now.

Until next time, stay Sovereign…

Jeff D. Opdyke
Editor, Profit Seeker


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