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Oil Prices < $40/Barrel?

Marin Katusa vs. Porter Stansberry on Oil Prices

At the latest Casey Research conference, respected investment analyst Porter Stansberry stood at the podium and predicted that the price of oil will fall below US$40 per barrel within the next 12 months. Part of his reasoning revolves around the impact that the shale gas revolution has had in the United States – he believes a similar thing will happen with oil.

Porter is a friend of mine and a very smart, successful individual… but I think not.

From my perspective, the pressures at play in the oil market are all pushing prices in the opposite direction: up. Global supplies are tightening, costs are rising, and demand is not falling. Prices are going to remain high, and then go higher. And there will not be a shale oil revolution anytime soon.

I’m the kind of guy who puts his money where his mouth is, so I challenge Porter to a bet. I bet Mr. Stansberry that the price of oil will stay above $40 a barrel over the next 12 months. The wager? 100 ounces of silver.

Porter has made a lot of good calls in his career. I highly recommend watching his video The End of America, an interesting and entertaining look at his prediction that the US will soon drown in its debts and cease to be a global economic powerhouse, a transition that will lead to riots across the country.

Porter and I agree on a lot of things, but on this one he’s wrong. Below are my top ten reasons that high oil prices are here to stay.

Reason 1: “The Big Pinch”

Oil production levels, as well as exports, have been falling in most of the world’s top ten supplier nations:

Top Global Oil Suppliers: Four-Year Production and Export Changes (thousand barrels per day)
Country
Production
Exports
2006
2009
Change
2006
2009
Change
Saudi Arabia
9,152
8,250
-9.9%
7,036
6,274
-10.8%
Russia
9,247
9,495
2.7%
5,106
5,430
6.3%
Iran
4,028
4,037
0.2%
2,540
2,295
-9.6%
Nigeria
2,440
2,208
-9.5%
2,190
2,051
-6.4%
UAE
2,636
2,413
-8.5%
2,324
2,036
-12.4%
Iraq
1,996
2,391
19.8%
1,480
1,878
26.9%
Norway
2,491
2,067
-17.0%
2,176
1,759
-19.2%
Angola
1,413
1,907
34.9%
1,393
1,757
26.2%
Venezuela
2,511
2,239
-10.8%
2,349
1,691
-28.0%
Kuwait
2,535
2,350
-7.3%
1,760
1,365
-22.4%

 

The “Seven Sisters of Declining Exports” – Saudi Arabia, Iran, Nigeria, the UAE, Norway, Venezuela, and Kuwait – share one common characteristic: their oil fields are old. Oil fields don’t produce the same amount year after year. They decline significantly from one year to the next because each barrel of oil taken from a reservoir reduces the pressure within the field, leaving less force available to push the next barrel of oil up the well. But don’t take our word for it. The following chart shows production from Alaska’s North Slope oil field in the past 30 years:

(Click on image to enlarge)

Another example? The Cantarell field in Mexico, which produced 2.1 million barrels per day in 2003, produced just 400,000 barrels last month, a staggering decline of more than 80% in just nine years.

To maintain output levels, producers need to consistently invest huge amounts of money and time in exploration, development of new areas, and engineering and utilizing new technologies to extend oil field lifespans. All of this costs money, and lots of it. Of the Seven Sisters of Declining Exports, six are countries where the oil machine is run by a national oil firm. That means that revenues from oil exports belong to the government… and those governments are stuck between a rock and a hard place.

They know they need to direct the oil revenues back into their fields very soon, before they decline beyond the point of repair. In the meantime, production levels continue to fall. Compounding the problem of declining production is the fact that most of these countries have long relied on cheap domestic fuel prices to keep their citizens happy. This has spurred rising consumption in many oil-producing countries, including Saudi Arabia, Iran, Nigeria, United Arab Emirates, Venezuela, and Kuwait.

With domestic consumption climbing and production falling, these countries have less oil available for export every year. But here’s the hard place: oil export monies make up the vast majority of each government’s revenue. They need to sell oil on the international market in order to fund their day-to-day operating expenses. And their operating expenses are sky high: these governments constantly make new social-spending promises to appease their masses; and since their populations continue to grow, these commitments grow larger with each passing day.

Venezuela is a prime example. Hugo Chávez owes a big chunk of his popularity to the domestic fuel subsidies that render fuel prices in Venezuela among the lowest in the world – it costs just US$0.18 per gallon to fill up in Venezuela, and that’s ridiculously expensive compared to the US$0.05 per gallon it cost a year ago. Yes, that means you could have filled your car for $1 in Caracas.

Getting rid of these fuel subsidies would solve part of the problem, but it is simply not doable – it is not just political suicide, but a sure-fire way to incite riots and social unrest. Just a few months ago Nigeria’s government tried increasing domestic gas prices; the country rapidly descended into violence as protestors demanded a return to subsidized fuel. The government relented within days.

Fuel subsidies are not the only expensive item on many a government’s social-spending list. Housing, food, health care, education – these are all burdens that socialist-tending governments take on to cement support. Social spending is a great way to make yourself popular with your citizens, but it is also a great way to bankrupt your country… unless, of course, you can sell oil at high prices to other countries. According to our analysis, OPEC nations need the price of oil to stay above $60 per barrel to pay for all their social programs. In other words, they need $60+ oil to stay in power – and you can be certain they will do everything necessary to make sure this happens.

To sum it up: Governments in most of the world’s key oil export nations need more money from fewer barrels of oil, and it is a lot easier to hose your international customers than your own citizens. This results in “The Big Pinch.”

What is “The Big Pinch?” In simple terms:

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