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The Number One Reason You Should Invest in Oil Stocks

Screw OPEC!

Written by Geoffrey Pike
Posted October 10, 2014

The price of oil has been trending down lately, which is a concern for countries that rely heavily on oil sales.

The lower prices may partially reflect the typically lower demand following summer, along with increased supplies, especially in the United States. It is also possible that the economy is weaker than what is reported and that demand is lower because of this.

At a meeting to be held in Vienna in November, oil ministers from the OPEC countries may agree to adjust their output of oil in order to keep prices from dropping too much.

Some call this price manipulation, and it really is. But what does it accomplish? If a country cuts its output to keep prices from falling, it will be selling less oil. So either way, it is going to mean less money in sales.

It is estimated that OPEC countries control about 60% of the world’s reserves, with one-third making up the daily supply used. If OPEC were to purposely cut production, there are still other countries that would not cut back. These other producers would actually benefit from a price increase because their sales volume would not be cut.

Iran’s oil minister is leading the call to cut oil production, while many officials of the Arab countries — particularly from Saudi Arabia — are less enthusiastic about such a move.

This is not surprising, as Iran’s economy is in much worse shape due to sanctions and bad economic policies. Meanwhile, some of the Gulf Arab states are practically overflowing with cash.

In the U.S., shale oil drillers have seen a boom over the last several years. But it can cost up to $80 per barrel to extract the shale oil, meaning it won’t be profitable if the price of oil goes down much further.

Supply and Demand

While OPEC is something of a cartel, these countries are still not immune to the laws of supply and demand. They can attempt to manipulate the price of oil in the short term and may even succeed a little bit, but it can’t last long.

Oil is fungible. In some places, it is easier to pull out of the ground than in other places. But a barrel of oil is a barrel of oil. It is like the dollar bills in your pocket. You can exchange a one-dollar bill for another, and it is worth the same thing.

If OPEC cuts oil production, it will probably just be hurting the countries that cut production, since some countries won’t. It will also mean there is a larger supply in reserve for the future, which would inevitably bring the price back down.

Some people defend U.S. government intervention in the Middle East strictly on the basis of oil. They say it would have been really bad if Saddam Hussein had taken over Kuwait in the early 1990s and controlled all of that oil.

But what would Saddam Hussein have done with all of that oil? He wasn’t going to drink it. It is only useful if you use it or sell it.

Most countries in the Middle East aren’t going to use a lot of oil. It is the most economically advanced countries, such as the United States, that use the most oil. Most of the oil coming out of the ground in the Middle East is exported in exchange for money or other forms of wealth.

Even ISIS in Iraq is currently selling oil. Maybe it has to sell it at a slightly reduced price because it is not done as openly, but we can be sure that the price of this oil is something similar to the market price. Most oil consumers aren’t going to pay a higher price than the price on the world market.

No Free Market Here

While many Americans like to criticize OPEC for rigging the oil markets, and correctly so, they don’t realize the bad policies of their own government.

Some recognize the environmental restrictions and the regulations that make it difficult to drill for oil and build refineries. But many do not know there is a ban on exporting American oil — it has only recently become news again.

In the 1970s, during the era of wage and price controls, there was a ban placed on exporting U.S. crude oil. This made political sense at the time in relation to price controls because exporters would have sold their oil outside the borders for more money, since they were limited to how much could be charged internally.

But when price controls were lifted, the ban on selling oil wasn’t.

Just about every president since that time has called for energy independence. With oil being a fungible good in a global economy, this goal of energy independence doesn’t make any sense. We don't call for food independence, clothing independence, or cell phone independence. What’s so special about oil?

As for the ban on exporting oil, it hasn’t had much of an effect over the last four decades because the U.S. consumes far more oil than it produces. This would be similar to having a really low minimum wage when most people are making above that rate anyway. It is virtually irrelevant.

But as oil production has picked up, the policy is becoming more harmful. There could be cases where it makes sense to export oil from certain locations in the United States.

Ironically, if the ban has any effect at all, it's making oil more expensive for Americans. If it were more cost effective to import oil in some locations and export it in others, then this would mean reduced costs. This should be for the market to decide and not some old government policy that was enacted because of another disastrous economic policy (wage and price controls).

The Future for Oil

I don’t know if the export ban will be lifted anytime soon. I don’t know if OPEC will announce a cut in production at its next meeting. I also don’t know if the world will run out of oil or if vast new reserves will be found.

But I do know that in the long run, big countries like China and India are likely to consume more. I don’t expect peace to break out in the Middle East anytime soon, but anything is possible. I also don’t expect the Federal Reserve to stop its monetary inflation for long, which will only drive up the prices of real assets, including commodities.

One hundred years from now, there will probably be a new and cheaper source of energy. It will be found by the marketplace.

But in the next 10 to 20 years, I don’t expect the use of oil to go away. So if you expect the Fed will continue creating money out of thin air, and if you expect that chaos will continue to reign in the Middle East, then buying oil stocks will likely be a good long-term play.

You can buy a mutual fund such as FSESX or find a couple of the big energy companies in the U.S. to invest in. As part of a small speculation in your overall portfolio, you won’t go wrong with energy stocks if you plan to hold them for the next several years.

Until next time,

Geoffrey Pike for Wealth Daily

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