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Here's Why Oil Prices Are Going Higher

Written by Briton Ryle
Posted May 15, 2017 at 6:14PM

Oil prices are cooking today. In the pre-market, crude was up over 3% — about $1.50. No doubt traders are watching that magical $50 level. Why is $50 a barrel for crude so important? 

Because when prices are above $50, investors are happy to focus on how OPEC and Russia's production cuts are helping the world work off the massive amount of oil that's gone into storage over the last couple of years. But when crude falls below $50, where it has been for the last few weeks, the conversation changes to how a surge in U.S. production is offsetting the cuts OPEC and Russia agreed to.

And as the price remains weak, investors start to ponder why demand isn't growing much and if the global economy is actually weakening right before their eyes. 

I say oil is going to trade higher. It's going back over $50 very soon, probably this week. And crude prices will likely finish the year over $60 a barrel.

The reason I say crude prices are going higher has nothing to do with U.S. oil production, global economic growth, or oil demand. It's much simpler than that.

Simple and scary. 

Oil prices are going higher because Russia and Saudi Arabia want them to go higher. 

Money Makes the (Under)World Go Round

Russia and Saudi Arabia are the world's biggest oil producers, accounting for around 20 million barrels a day. Not only that, but both countries are downright scary when it comes to pursuing their objectives. 

I mean, imagine you're the oil minister for Algeria, or Nigeria, or Venezuela at the OPEC meeting that's coming in 10 days. The Russian oil minster turns to you and says, "President Putin says he hopes you and your family are in good health these days." And the Saudi minister just fixes you with a cold stare. 

I don't know about you, but I'd be a little nervous I was going to find some polonium in my corn flakes or a plane was going to fly into my office building. 

Yeah, the Saudis and the Russians don't play. And they don't just want oil prices higher — they need oil prices higher. Because oil revenue is the basis of their power, and cash flows have been a little weak lately...

Saudi Arabia's plan to crush U.S. oil production and retake control of the global oil market blew up in its face. To paraphrase Nietzsche, the oil price crash didn't kill U.S. oil companies — it made them stronger. And it made Saudi Arabia weaker.

Over the last couple of years, the Saudis have had to spend about half of their foreign currency reserves to meet their budget. They've also sold bonds, cut wages, and ended subsidies in the kingdom. Generally, people don't like it when you cut their wages. 

So, in just the last few months, the Saudi king reversed the wage cuts and also cut the tax rate for the Saudi oil company Aramco. In other words, they will spend more and get less income from Aramco. 

Of course, they are doing both of these things because they expect a windfall when they take Aramco public in 2018. And the only way the whole scheme works is if oil prices are higher than they are right now. 

The Biggest IPO Ever

So, the Saudis plan to sell 5% of Aramco to global investors. Currently valued around $1.5 trillion, Aramco, with its 260 billion barrels of oil, is the most valuable company. The Saudis would take in around $150 billion on the deal. But they would also continue to collect tax revenue and dividends from the company. Plus, they'll be sitting on a boatload of stock they can sell whenever they need some cash. 

Basically, this has to happen. The Saudis are literally banking on it. And this is one of the few times your interests as an investor dovetail nicely.

But let me be clear: I am NOT talking about buying into the Aramco IPO. I trust the Saudis about as far as I can throw them, and that's not very far. I do not for a minute believe the Saudis will play by the rules. 

I believe they look at Western and Asian investors and think they (we) are greedy and stupid fools who will happily fork over billions to the Saudi royal family. I haven't forgotten 9/11. I don't believe the Saudis have America's interests at heart. I am very glad Americans can now sue the Saudi government over 9/11, and I'm even more glad that means the Aramco IPO will not be listed on the New York Stock Exchange.

In fact, I can't imagine anything more insulting than Aramco trading on the NYSE, just a few blocks from where the towers once stood. 

As for Russia, I think Putin will throw in with anybody who can help him make money. Right now, that's the Saudis, so he's in. 

As for you, I think buying an oil stock or two is a really good idea. They've been creamed over the last few weeks. But I believe new production cuts from OPEC and Russia are coming on May 25. Oil will be headed back to $55 by the end of the month and $65 by the end of the year. And many U.S. oil stocks have ~50% upside coming. 

Finally, focus on Permian Basin stocks, like this gem my colleague Keith Kohl has his eye on. The Permian has the lowest-cost oil in the U.S. right now, so these companies should perform best.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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