Oil producers are in a game of economic chicken, waiting for the other guy to slow production first to reduce the glut of oil on the market and raise prices.
For decades and decades, the oil-producing countries of the Middle East controlled the price of oil, and thus controlled the price of refined petroleum, or gasoline. Employing the age-old economic standard of supply and demand, the Organization of Petroleum Exporting Countries (OPEC) toyed with output numbers to keep the supply down and the price high.
But the combination of American, Canadian and Russian oil production and energy-saving efforts worldwide have created a situation where there is a distinct glut of oil throughout the world, and the price of gasoline in the United States continues to drop as a result.
For some reason, however, OPEC and the other oil producers are continuing their strong output, as the gas-consuming public shouts Hallelujah! and the price keeps going down. And that is before the possibility of Iran reentering the market after a possible nuclear-arms deal with the United States and other world powers takes export restrictions off the volatile country.
According to Bloomberg, Russia is pumping 10.6 million barrels of oil a day and increased production from January through July when compared to a year ago, when prices were at least $1 higher.
Apparently, Saudi Arabia thought the glut and the ensuing drop in prices would cause American companies to slow output, which would benefit the Saudis as they maintained current levels of output. From a recent statement issued by the Saudi central bank:
“It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run. “The main impact of the current low prices has been to cut back on developmental drilling of new oil wells rather than slowing the flow of oil from existing wells. Thus, the impact of lower prices today is expected to be on future oil production rather than current production. This requires more patience on OPEC oil producers and w willingness to maintain steady production until the demand catches up with the currently supply levels.”|
Apparently, the ploy is to wait for someone to blink and reduce output first, which would increase the value of all of that oil currently on the market, sitting in warehouses. But American companies producing oil from shale have a much lower break-even price for gasoline, meaning they can still profit from lower gas prices while OPEC nations cannot.
But there is another player in the market: hedge funds. Producers were able to lock in prices on derivative contracts when the price of gas was still high, so they are fulfilling those contracts currently and getting far more than market value for the price of gasoline. Those contracts, however, are all short-term, and any new deals will reflect the market glut and reduce prices.
Numerous companies report an increase in rig construction to increase output. MSN Money reports that both Cimarex Energy Co. and Pioneer Natural Resources Co. announced plans to double their rig count in 2015, and in both cases, share prices increased significantly.
At the same time, output from the five dozen shale producers in the United States increased 19 percent in 2014, and increased again another 4 percent more the second quarter of 2015 than in the final quarter of 2014.
The goal, it seems, is the increased cash flow that comes from a rise in stock prices. Investors react positively to growth, and negatively to a decline in production, so companies maintain plans to increase output to satisfy stockholders and future investors.
One company that has restricted output has seen the exact opposite happen, proving the point that cash outweighs consideration. In 2014, EOG Resources Inc. allowed crude output to decline for the first time since the recession, and as a result, it saw a drop in stock prices of 5 percent following an announcement from CEO Bill Thomas that the company is going to wait for higher prices before returning production to previous levels.
Kent McDill is a staff writer for Millionaire Corner. McDill spent 30 years as a sports writer, working for United Press International and the Daily Herald of Arlington Heights, Ill. From 1988-1999, he covered the Chicago Bulls for the Daily Herald, traveling with them every day through the nine-month season. He also covered the Bulls for UPI from 1985-88, and currently covers the team for www.nba.com. He has written two books on the Bulls, including the new title “100 Things Bulls Fans Should Know And Do Before They Die’, published by Triumph Books. In August 2013, his new book “100 Things Bears Fans Should Know And Do Before They Die” gets published.
In 2008, he resigned from the Herald and became a freelance writer. The Herald hired him to write business features and speeches for the Daily Herald Business Conferences and Awards presentations.
McDill also writes a monthly parenting column for the Herald’s Suburban Parent magazine.
McDill is the father of four children, and an active fan of soccer, Jimmy Buffett and all things Disney.