The Big Oil Conspiracy

Who doesn't love a good conspiracy theory?

The problem with many–beyond the question of whether they’re actually real–is that most of them aren't actionable. It’s hard to make money off something that hasn’t been proven, right?

Actually, wrong… at least in the case of the Big Oil Conspiracy, which theorizes that the oil price spike is actually a weapon in the trade war.

When the price of oil rises, it produces a defined set of winners and losers. By investigating who or what exactly is behind a rise in oil prices, fluctuations become easier to understand.

This expanded understanding and insight can also help you, the investor, more accurately predict the effects on commodities, industries and economies as a whole.

Point in case. The obvious winners for higher oil prices are net exporters of the commodity, such as Russia and the OPEC cartel of oil producing nations.

Remember… the price of oil is set, like pretty much all commodities, by the law of supply and demand.

However, supply is not equal to the amount of oil available in the world, but rather by the amount that sellers have decided to sell, and by the total supply and demand of the broader category of energy in the world.

For the last four years, the price of oil has been historically low, even hovering around US$30 a barrel at one point. This has really hurt many producers, who have struggled to make up for the missing funds in their coffers.

These low prices put severe strain on countries such as Russia and Venezuela, which rely heavily on oil sales. Russia, for example, generates around 40% of its state revenues through oil sales.

So why didn’t they simply agree to sell less? Well, OPEC doesn’t have the same power to affect prices via supply as it once did, and such a move would have hurt the global economy, potentially decreasing demand.

But now, as liquidity has risen and the economy has expanded, higher demand for oil is driving up prices.

And while the U.S. is still the biggest importer of oil, it has over the last four or so years been actively decreasing its reliance on oil imports through expanding fracking operations and extracting its own shale oil.

It’s now at a point where it seems poised to agree with Russia on one thing: high oil prices are not so bad.

Especially if Iran is not allowed to sell it to anyone. And even better if it forces rivals to cough up more cash if they want to keep growing.

2018-10-02_1526.png

So who are the losers? Put simply, the net oil importers. And who is the biggest net importer after the United States?

You guessed it. China.

The U.S. is on track to become the largest producer of oil, followed by Russia and Saudi Arabia.

U.S. conventional and unconventional oil reserves totaled 50 billion barrels at the end of 2017, representing a potential US$3.46T for the U.S. oil industry.

However, what separates the U.S. from Russia and Saudi Arabia is the fact that it doesn’t export much of it. In fact, it is also the highest importer of oil, which it requires in order to keep its massive economy running, literally.

Now zoom out to the trade war unfurling between the U.S. and China...

When China released its second list of US exports threatened with retaliatory tariffs, almost all fossil fuels made the cut, including oil, coal and liquefied petroleum gases such as propane.

However, U.S. oil exports to China were not so high to begin with. What China does import a lot of is Liquefied Natural Gas (LNG)–from nothing in 2015 to 17bn cubic feet in 2016 to 103bn cubic feet last year.

LNG conspicuously didn’t make the list of new tariffs.

So what does this all point to?

Well, the U.S. has likely scored some points with Saudi Arabia and Russia on a range of geopolitical issues, from Iran to Syria and North Korea.

The severing of the Iran Nuclear Deal and re-imposition of sanctions makes it easier for countries like Saudi Arabia, and to a lesser degree Russia, to allow oil prices to rise, as it doesn’t benefit their regional rival.

And it also means China has to rely even further on U.S. LNG, which it can’t even afford to include in its expansive new tariff package.

The takeaway?

Watch LNG and related industries do well as oil continues to climb. But if it climbs too high, the added cost for net importing countries without LNG processing infrastructure could in theory spark the start of the dreaded second recession.

And if you're investing in or working with commodities, we're proud to announce a new investment indicator called the Commodity Investment Cycle.

We created this indicator to help investors forecasts the prices of commodities and their stocks by tracking the 'Commodity Cycle'. And as a Decoding Asia subscriber, you are the first to hear about it.

Click here to view the Commodity Investment Cycle index.

Peter Pham