Inevitable Oil Profits

I’ve been telling you this was going to happen. For a few months now, it’s been obvious that oil stocks were a screaming value.

Why?

Because oil prices were being manipulated by the Saudis. The Saudis have been oversupplying the markets for nearly a year now. It’s been a deliberate attempt to drive oil prices lower, pressure U.S. shale companies (as well as other OPEC producers like Russia and Iran), and take market share.

As I’ve pointed out, it’s a stupid strategy. Sure, the Saudis have taken market share. But at what cost?

Saudi Arabia has lost well over $100 billion in oil revenue by taking more market share and selling more oil. (No, you can’t make it up with volume.)

What’s more, Saudi Arabia has had to tap its foreign reserves savings in order to make its budget work. And it’s had to sell bonds, too, to raise more cash to make ends meet. Yeah, great strategy there…

The thing about price manipulation is that you can’t do it forever. It’s an imbalance in the market. And whenever there’s imbalance, somebody will figure out how to take advantage of it. You can only fool all of the people some of the time…

Won’t Get Fooled Again

Among other things, the story goes that Saudi Arabia has been trying to push U.S. oil producers out of business — or at least get them to cut production.

And now, U.S. production cuts are happening. The Energy Information Agency (EIA) says September U.S. production fell 120,000 barrels per day from August, and full-year U.S. production will fall by around 400,000 bpd next year.

Like any commodity, oil prices are ruled by supply and demand. If there’s too much supply, prices fall. That’s where we’ve been with oil.

But when prices fall, you expect demand for the commodity to increase. That’s also been happening. Low oil prices have encouraged gasoline refiners to buy and refine more oil into gasoline and diesel fuel, much of which gets exported.

And low gasoline prices also encourage people to drive more. That’s also been happening. Global demand is expected to be up 150,000 bpd this year to 93.79 million barrels a day.

Yeah, that may not sound like a huge swing. But if the U.S. does indeed cut production by 400,000 bpd next year, it puts a big dent in the oversupply story. And that’s why oil prices — and oil stocks — have rallied over the last few days.

My favorite oil stock (one that I have written about here in Wealth Daily) was an $8.50 stock last Tuesday. Today, Oasis Petroleum (NYSE: OAS) is $12.50, and that’s after dropping from $13.50.

The End is Nigh

Oil investors know that oil prices cannot remain under $50 for long. Or at least they know it’s a grave error for Saudi Arabia to take on debt to keep prices low. There will come a point when the Saudis decide enough is enough.

I can’t say exactly when that will be. But it should be impossible to miss what the future for oil demand is: down. The world is going to use less and less oil as electric cars take over the roads. Look around; I bet you see a couple electric cars — whether it’s a Tesla, Chevy Volt, or even those cool new BMWs — every day.

Here in Baltimore, I see at least five a day. People are buying them. I just bought a new Mazda 18 months ago, and I’m pretty sure my next car will be an electric one.

I’m 50 years old. I’m a bit stuck in my ways and don’t jump on the latest gadgets or trends easily. But if I can see what’s coming, you can bet others do. I think electric cars will be adopted by the masses a whole lot faster than most people think.

Anyway, my point here wasn’t to go off on electric cars. The point is really that oil is a finite resource, and it doesn’t make any sense to sell it at a price that’s roughly 50% lower than what you could get if you don’t have to.

Between April and July, Saudi Arabia increased production from 10.1 million barrels a day to 10.45 million barrels a day. That’s a 340,000 bpd increase. And the Saudis sold that oil for $13 million a day less than they need to. It doesn’t make much sense.

What’s Next?

The effect of low oil prices has been mixed.

On the one hand, Americans save money at the pump and spend it elsewhere. On the other hand, S&P 500 earnings are down more than 10% because oil companies are making much less money. That’s made the stock market look expensive.

And that’s why the market has rallied along with oil. If oil companies can make more money, they will report higher earnings, and that makes the stock market look better from a price-to-earnings (P/E) perspective.

Credit Suisse estimates that the lack of spending by oil companies has helped shave nearly one point off GDP. That’s a big number. But Credit Suisse also thinks the worst is over for U.S. oil companies.

What happens next depends on the Saudis.

Again, I can’t tell you when the Saudis will cut production. But they will. And I doubt they’ll wait much longer, as they are running a budget deficit when they don’t have to.

So pick up some shares in U.S. oil producers that have a solid balance sheet and wait. As we’ve seen with Oasis, these stocks can give you +50% gains quickly.

And when the Saudis cut and oil prices move above $60 to $70, you’ll probably get some triple-digit winners.

Until next time,

Until next time,

Briton Ryle

@BritonRyle on Twitter

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A 21-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 is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.