All the talk about oil these days would lead you to suspect that we are overflowing in abundance, with enough of the black gold lying around the U.S. to significantly reduce our dependence on Middle Eastern and European oil. This happy talk has even sparked discussion of oil independence for Americans — but this couldn’t be farther from the truth. Given the rising cost of producing oil, oil prices won’t fall below $100 a barrel — at least not for any significant length of time.
Indeed, U.S. oil production is on the rise and very well may continue that way into the latter part of this decade, but it is still far short of providing enough oil for the U.S. to become independent of foreign supplies.
While analysts and the talking heads continue to tout American oil independence, the everyday people of America are missing out on a key fact. One that tells us much more about the direction of oil prices, instead of filling your dreams with false hopes…
Oil discoveries have fallen off a cliff. In 2013, the world had one of its lowest years on record for proven oil discoveries. We discovered only half as much oil as we consumed — and this downward trend is on pace to continue this year into next as companies focus on building cash flows instead of exploration.
There is no doubt this is a product of the environment we’re in — both skepticism in the stock market and the rising price of oil.
Since the recession, investors who have been hesitant to invest in the shaky stock market for the long haul have focused on short-term rewards — increasing earnings, growing cash flows and improving balance sheets, leaving behind more long-term prospects like oil reserves.
But the other key reason exploration is declining is because of the price of oil.
In order for companies to continue to scour the globe in search of new reserves, they need the price of oil significantly higher than it is exchanging hands at today — and therein lies our profit opportunity.
The Growing Cost of Deeper Oil
The global oil market is currently sitting pretty with a surplus of reserves, but given the rate of consumption, this can quickly change. The current pace of production is less than half of consumption growth — presenting us with a growing gap that chips away from our global reserves each year.
Given the situation, America and the world will eventually have to rely on oil that comes from new discoveries — the same discoveries that have hit record lows lately. And these newfound sources are likely to be unconventional shale oil, oil sands or even ultra-deep water wells.
That means it is becoming increasingly more expensive to find and produce oil each year. Jeff Opdyke, our Investment Director, has been asserting this for years to his Sovereign Investor monthly subscribers — even as the pundits were claiming oil would fall to $50 a barrel. One of his preferred arguments against cheap oil was the cost of drilling in these increasingly expensive resources — some of which are 6,000 feet below sea level and cost over half a billion dollars to build and operate.
These extensive costs have caused oil companies to hesitate about spending money, but as our reserves continue to deplete, they will soon have no choice but to spend these exploration costs in order to meet global demand — meaning the price of oil is destined to climb higher.
Wall Street knows this. It’s why they have seemingly put a floor in the price of oil. Granted, this floor can be breached on a temporary basis, but it will only last a day or two before the price of oil rallies again. This has held true for three and a half years now — and we can expect it to stay true for many years to come as oil continues to tear away from that floor.
Take a look for yourself:
Price of Brent Crude Oil
As you can tell, it never stays at that floor for long, thus affirming our argument that a low maximum cost of oil is complete balderdash.
But there’s something else in that chart that you may not have noticed — whenever the price of oil drops below $100, it spikes back quickly and sharply.
With the price of Brent crude sitting around $102, I am confident that we will see a bounce higher any day now.
A Little Bit of Everything
And going forward, I think we will see oil test the $150 price mark more often than the $100 floor, with the occasional spikes towards $200 as the oil discovery cliff catches up to consumption growth.
Even the U.S. Energy Information Administration (EIA) believes the risk of oil is to the upside. They have a low-range price of oil at $75 by 2040. Its high range … is $237 per barrel. Considering the price of oil was $110 when they made these determinations, this range represents a 30% swing to the downside or a 110% curve to the upside — the type of risk/reward I like to find.
While I ordinarily prefer to pick stocks as opposed to ETFs, I believe this is an opportunity that will benefit the entire industry, so you don’t necessarily have to try and pick a winner. The easiest way to ride this bounce higher is by investing in the iShares U.S. Oil and Gas Exploration and Production ETF (NYSE: IEO).
I know this ETF also has some exposure to the gas side, but all of the large players these days have exposure to that. The point is, IEO gives you exposure to some of the largest players in the oil business — ConocoPhillips, Phillips 66, Marathon Oil and Anadarko Petroleum, just to name a few —so you can feel secure that you as an investor are getting diversified exposure to a variety of different companies.
This ETF dropped about 10% alongside the fall in the price of oil, but rebounded quickly. Instead of deterring you, let this speak to the fact that this sort of investment follows wherever oil is going.
Which means that, as the price of oil rallies from its floor of $100 a barrel, IEO will surge higher as well.
Regards,
Chad Shoop
Editor, Pure Income
The post Why Oil Prices Won’t Fall Below $100 a Barrel appeared first on The Sovereign Investor.