Go To

$400 Oil? Don’t Bet on It

The price of oil has rocketed over the past couple of years, by more than 200% from its bottom in mid-January of 2016 to $85 per barrel in recent weeks. One of the factors fueling that rally has been the institution of new economic sanctions on Iran by the Trump administration. Some analysts believe crude could have further to go as those sanctions take effect next month, with some forecasting that it could top $100 per barrel once again.

That may only be the beginning: The suspicious disappearance of a journalist — who is both a U.S. resident and a prominent critic of Saudi Arabia — could cause the Trump administration to also impose sanctions on that Middle Eastern country. If that were to happen, “no one should rule out the price [of oil] jumping to $100, or $200, or even double that figure,” according to a recent op-ed by the general manager of a Saudi-based TV station. While his prediction is making headlines, it’s not likely to come to fruition.

A doomsday prediction

It has been almost two weeks since journalist Jamal Khashoggi disappeared after entering the Saudi consulate in Turkey. The Turkish government claims that Saudi Arabia had him murdered, which Saudi Arabia has flatly denied, though recent reports suggest the country has admitted that he was killed during an interrogation attempt.

President Trump, meanwhile, threatened “severe punishment” against Saudi Arabia if it turned out that the country was behind the journalist’s disappearance. The Saudis countered by saying that they would retaliate if hit with sanctions; those could include turning off the country’s oil supplies, which currently account for 10% of the global total. “It would lead to Saudi Arabia’s failure to commit to producing 7.5 million barrels (per day),” according to the op-ed, and that likely would send crude prices skyrocketing. The world can’t afford to lose any more barrels since the oil market is already starting to enter a danger zone, according to the International Energy Agency (IEA), which recently called on Saudi Arabia to pump more oil.

With the oil market tightening, and oil prices rising, the IEA is starting to see some erosion in projected demand growth. It recently reduced its forecast for demand growth in 2018 and 2019 by 110,000 barrels per day each year, due in part to the impact higher oil prices are having on the global economy. If Saudi Arabia suddenly withheld millions of barrels per day, it would be “an economic disaster that would rock the entire world,” according to the op-ed writer.

No one can afford this game of chicken

While the U.S. can threaten sanctions on Saudi Arabia, Americans can’t afford to have it shut off the taps. That’s because the Saudis supplied about 9% of America’s oil imports last year, an amount sizable enough that it would be tough to replace, especially since pipeline constraints in Canada — which supplies 40% of America’s oil imports — and the Permian Basin have stunted the growth potential of both regions. Meanwhile, Venezuela, which provided 7% of America’s oil imports last year, has seen its oil production fall off a cliff in recent years, and is expected to decline even further due to that country’s economic troubles.

At the same time, Saudi Arabia can ill-afford to cut off its oil supplies from the world market. The nation currently gets about two-thirds of its fiscal revenue from oil. While it’s aiming to get that below 50% in the future, it needs petrodollars in the meantime to achieve its diversification plan. That’s especially true after enduring a tough stretch in recent years due to lower oil prices, which forced the kingdom to tighten its fiscal belt. If it turned off its oil pumps to punish the U.S., the action would not only cut into its revenue but could wreck global demand. The demand destruction alone from skyrocketing crude prices could quickly cause a reversal in prices, though likely not before inflicting serious long-term damage to the oil market.

Look for oil stocks that can thrive no matter what happens to oil prices

Geopolitical risks have the potential to increase oil market volatility in the coming year, with attention-grabbing headlines calling for big price spikes, and the increasing likelihood that crude will plunge if the global economy slows down. Investors need to brace themselves for what could be a wild ride. One way to do that is by owning oil stocks that can thrive no matter what happens to crude prices.

Two great options to consider buying in light of the market’s current uncertainty are ConocoPhillips (NYSE:COP) and EOG Resources (NYSE:EOG). Both oil producers can thrive even if crude prices were to plunge below $50 a barrel. At that price point, ConocoPhillips could still grow its production at a 5% compound annual growth rate (CAGR) while EOG Resources could boost its output at a 15% CAGR.

Meanwhile, at higher prices, both companies would be able to increase their dividends at a high rate, while ConocoPhillips could also buy back a boatload of stock and EOG could pay off even more debt. Their flexibility to thrive, no matter what oil does, has them in a strong position to continue creating value for their investors over the long term.

source: fool.com

Comments are closed.