Summary
Saudi Arabia can or is no longer willing to sustain low crude oil prices.
Last round of public sector benefit cuts and large budget deficits indicate that the country is losing the oil war.
OPEC's decision to curtail production is a big win for U.S. shale oil companies.
I think oil can hit $60 in the next couple of months. Here are my two top bets for rising oil.
Last week, the Organization of Petroleum Exporting Countries (OPEC) delivered a major surprise to world energy markets. The organization, which has earned a reputation for ineffective decision-making (and some would say for paralyzing itself, too) has agreed to curtail production in November in a bid to support crude oil prices.
With crude oil languishing below $50 a barrel, the cartel's (and the world's) biggest producer, Saudi Arabia, is hurting. For some time, though, Saudi Arabia was more than willing to accept lower crude oil prices. Even 'lower-for-longer' prices were OK for Saudi Arabia in order to meet its strategic objectives, but there can be now doubt that the country is hurting.
Saudi Arabia only recently announced that it would slash benefits for public sector employees, which includes holiday and annual leave benefits, and top officials were said to have to accept a 20 percent pay cut, too, in order to rein in spending. The oil price crash last year caused a $100 billion budget deficit in 2015, highlighting that Saudi Arabia is not winning the oil war.
It is important to understand how Saudi Arabia got here, though, because the country was a key driving force in resisting output cuts in order to kill two birds with one stone.
For one thing, Saudi Arabia kept pumping oil as if the end of the world was near because a persistent crude oil supply glut hurt U.S. shale companies. Their global market share has grown in the last few years, and they have become a formidable threat to the world's biggest oil producing country. While energy independence in the U.S. is great for America, it also meant that Saudi Arabia's dominance of the energy markets was being diminished.
Secondly, pumping oil hurt Saudi Arabia's arch rival Iran, which was just preparing to return to the world markets last year as it worked out a deal with the West to drop crushing sanctions.
OPEC Decision Positive Catalyst For Oil Prices
OPEC's decision to cut production this year - the first since 2008 by the way - suggests that Saudi Arabia can no longer cope with low oil prices. In fact, Saudi Arabia appears to be worn out, and the last round of public sector benefit cuts only serves to make this point.
In any case, last week's OPEC decision could kick off a new period of heightened interest in oil companies, and especially those that have been kicked to the curb during the last bear market.
Oil prices surged 6 percent after OPEC said it is prepared to reduce supply, and the agreement has been a major catalyst for energy companies so far. For instance, Seadrill's (NYSE:SDRL) shares surged ~20 percent on the OPEC news.
Read also: "Seadrill Limited: Game Changer?".
I have also penned a piece on U.S. energy company ConocoPhillips (NYSE:COP) lately, which I can see being a major profiteer from a sustained oil price recovery due to its reliance on higher price realizations to drive upstream profits.
Read also: "Want To Gamble On Higher Oil Prices After OPEC Deal? Buy This Oil Company".
Both Seadrill and ConocoPhillips are more than ripe for a rebound in my opinion.
Oil Heading To $60/Barrel?
All that was needed for oil prices to edge higher was a positive catalyst, and the OPEC agreement was just that.
Lower projected crude oil supply is an important signal to the market that the members of the world's energy price cartel are working more closely together in order to help energy markets rebalance. As far as I am concerned, the OPEC decision marks a major inflection point for oil, and there is a good shot that we will see crude oil edge up to $60/barrel over the next 12 months.
Your Takeaway
OPEC is back. OPEC's surprise deal has immediately led to higher world prices for crude oil, and the agreement is an important signal to the market that the price cartel will work together to limit supply in a bid to support higher prices. Saudi Arabia has resisted output cuts so far, but it has paid a high price for it. The Arab country is effectively throwing in the towel at this point, and it should help U.S. shale companies and offshore drillers in particular. My favorites to play an oil rebound to $60/barrel continue to be Seadrill and ConocoPhillips due to their very high dependence on higher price realizations. Both companies were clobbered intensely during the last downturn, which naturally makes them appealing bets for another market upturn.
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Disclosure: I am/we are long SDRL.
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