OPEC's War on OPEC

Summary

OPEC's greatest competitor is now OPEC. 

The real reason OPEC oil production levels will remain high. 

What the market is transitioning into. 

Is a real free market oil industry emerging? 

There are a lot of variables behind the reason the price of oil has plunged, as producers ramp up production in an attempt to maintain market share.

When Saudi Arabia and OPEC decided to boost production in response to the serious threat of U.S. shale oil, that was the primary impetus behind pushing prices down, in order to put extreme pressure on the quickly-growing shale competitors before they were too big to be dealt with.

As time as passed though, and U.S. producers have been forced to lower production levels and reduce exploration and development spending, a scenario has emerged that has gravitated to OPEC itself.

With Iran about to be released from sanctions, it has aggressively and publicly stated it will take steps to gain back market share it has lost, and will do what's best for the country, which was a reference to ignoring anything Saudi Arabia had to say about it.

more on OPEC battling OPEC

Saudi Arabia's Airports to be Privatized to Lower Budget Pressures

* Privatization of Saudi Arabia airports will reduce budget requirements over the next several years

* Over the next decade it two it could make a difference because of economic diversification, but not in the near term

* Vulnerability of Saudi Arabia to low price of oil


The cost of engaging in a long-term battle for oil market share is starting to weigh more on Saudi Arabia, which has drawn down reserves and borrowed in order to maintain most of its budget requirements because of falling revenue. Consequently, it has also had its credit rating lowered
by Standard and Poor's.

That will likely continue to be detrimental to the country as it has plans to increase it debt by issuing of billions more in bonds, which will probably result in more credit rating cuts, resulting in higher costs of doing business.

Saudi Arabia, at best, has about 5 years of reserves left, standing today at about $647 billion. Its budget deficit is now at about $100 billion a year.

Among the steps taken to slow down the process is to drop proposed projects, eliminate non-essential one's, and find ways to lower dependence on government largesse, which is about 90 percent dependent on the energy sector to drive revenue. The low price of oil is of course the negative catalyst driving the challenge.

Recently it was announced Saudi Arabia is going to privatize its airports in order to allow it to be freed from having to prop them up.

Airport strategy

Most Saudi cities of any decent size of a domestic airport in them, but the bulk of the value of privatization will be at its three international airports located in Riyadh, Dammam and Jeddah. The goal is to have all airports in the country privatized by 2020.

The project is scheduled to be launched in the first quarter of 2016, starting with the key international airport located at Riyadh. Once that is completed, all remaining airports will go private.

All the privatized airports and associated services will be managed by the Saudi Civil Aviation Company Holding, according to Business Times.

Some believe this is aimed at economic diversification. I don't. I see it as budgetary diversification, meaning it's cutting budgetary costs to reduce pressure on its reserves over time.

Value of the action

Saudi Arabia without a doubt knows the days of oil above $100 per barrel are over. It may even be making decisions on it struggling to reach $80 per barrel over the next five years. There is no way it can continue to afford the types of perks and subsidies its people have gotten used to, so it must take steps to reduce costs.

This is important to understand because it could be viewed as a growth mechanism if it is believe it's a move to diversify the economy, rather than to lower the budget.

That doesn't mean there won't be added value once the privatization takes place. In doing research over the years concerning the difference in performance of state-owned companies versus privately-owned companies, the private companies have always outperformed the state-owned companies. A good example of that is the Mexican oil industry.

What this should do is reduce the budgetary requirements over the next several years, as the airports start to compete on their own. This very well could be a benefit for the economy, as the increased efficiencies and customer satisfaction could boost revenue and earnings, and result in more hiring.

In my opinion that's not the reason for the move though. It's driven by the numerous risks associated with declining oil revenue. 

Saudi vulnerability to oil and oil prices

With about 90 percent of revenue coming from oil, the risk to Saudi Arabia is obvious. The current price war shows how quickly even this energy giant, which has the largest oil reserves in the world, can be taken down.

It's not taken down yet, but we now know it only has at most about a five-year time period to solve its problems under a low-cost oil environment.

That five-year period is subject to understanding it must take action long before that. Five years is how long it has before running out of reserves. It can't wait that long to deal with it, and it isn't.

Saudi Arabia basically makes the decisions on behalf of OPEC, and controls the economic fate of the Middle East members. There is risk there because it refused to give up market share, which has been putting enormous pressure on about half of the OPEC members, several of which are located in the region.

Even though Saudi Arabia has some time to respond to the issues, the other countries in the Middle East don't. If the result is unrest, the Middle East could go up in flames; far worse than we're seeing now with the ongoing wars there.

This has historically turned in to a contagion spreading across the region, which could easily appear in Saudi Arabia. On top of this Saudi Arabia is underwriting some of the wars against ISIS in different countries.

There are more risks, but you get point, which is the low price of oil, which will remain subdued, will only magnify these challenges until a decision is made or agreed upon to slow down production in order to support the price of oil.

Conclusion

I don't believe investors should consider this an attempt at economic diversification. After all, a publicly run airport still sends a passenger out on a plane in the same way a privately run airport would.

There will be some savings and possible an increase in revenue and earnings from the private airports, but that will be only a small part of the revenue the country takes in, and will have little effect on the reserves.

This is a cost-cutting move to remove some of the pressures on the budget of Saudi Arabia, to work in conjunction with the stoppage of projects it had in its pipeline, and the removal of those services that aren't considered of major importance to its people.

A lot further down the road this could be very important and productive, but over the next several years the value will primarily in reducing costs so its revenue can target those services considered essential to maintaining order in the country.

China Loading Up On Depressed Commodities

While the demand for commodities in China without a doubt has been weak, that doesn't mean China isn't a buyer in this market, because it is.

What must be understood is the demand now isn't domestic or for exports, but from the fact the prices have fallen so much, China, as it has done historically, is buying up the resources at bargain prices.

When measured by customs data, there are at least 21 commodities China has increased imports in by over 20 percent in July, according to Reuters.

Agricultural imports were especially strong, "with wheat up 158 percent, barley by 67.9 percent, corn by 1,184 percent, cassava by 28.5 percent, rice by 78.2 percent, soy oil by 25.8 percent, palm oil by 53.3 percent, natural rubber by 70.1 percent and sugar by 72.7 percent."

Crude oil imports jumped 29.3 percent in July.

Metals were also strongly represented. Molybdenum imports climbed 139.8 percent; uranium was up 227 percent; zinc ores up 84.5 percent, and silver up 63.3 percent, among others.

Among major commodities, copper ore and concentrates increased 7.2 percent, and iron ore imports were up a modest 4.4 percent.

What was also interesting in this was China's decision to increase imports at a time its currency was extremely weak. While low prices were definitely a part of the impetus, a declining yuan also had to play a part. If the currency loses more value, the cost of imports would rise even if commodity prices remained stable.

It looks like China was pressed into acquiring the depressed commodities before its currency weakened further. Or course China knows what its policy is going to be, and it's possibly a nod to further debasing of its currency after it buys the commodities it wants at low prices.

Parets Likes Natural Gas, Coal, Over Crude

Saying crude oil at this time "is a mess," J.C. Parets said in regard to energy and commodities in general, investors need to look elsewhere for gains, as he sees the fall from $100 as a trend that is likely to continue at this time.

Parets, who is the founder of Eagle Bay Capital, sees the energy place to be as natural gas, and says coal is also worth a look, as it could move up on the sails of natural gas.

He said, "If we're right on natural gas and continue to see higher prices, I think we should continue to see higher prices for coal as well."

The trend that needs to be followed at this time in the sector is natural gas versus oil, not crude oil in and of itself.

The reason natural gas is so appealing to Parets is it continues to be way below its historic 10-year average in relationship to oil, which has been about 10-to-1. In the spring of 2012 it jumped to 54-to-1.

China's Drop in Imports Not a Sign of Significant Slowdown

At first glance it appeared after the numbers came out in China concerning that the decline in imports pointed to a disaster in China. But that wasn't and isn't the case, but is rather a reflection of a commodity management strategy by the country.

When China announced its growth in imports had been slashed by almost half of analysts projected in June, traders and investors pushed down the price of commodities and equities, as coupled with weak financial reports from American companies, seemed to point to a catastrophic quarter.

Imports in China fell to 6.6 percent year-over-year in June, dropping from the projected 12.7 percent analysts were looking for.

Exports by the Middle Kingdom, on the other hand, jumped to 11.3 percent, easily surpassing the estimated 9.9 percent analysts estimated.

Most of the decline in imports to the company are a result of Chinese buyers building up commodity inventory over the last several months, which resulted in the need to use up those inventories before buying large in the market again.

For June crude oil and copper imports appeared to be hammered, with copper imports falling by 17.5 percent and crude by 15 percent from the prior month. Most should have known that there was something unusual about those numbers, even with the strained global economic situation we're in.

Expectations are China imports will probably be weak for several months while it works down its inventory.

It was noted by analysts covering China that the low imports have nothing to do with consumer spending in China, as it does in the United States, because Chinese imports are mostly commodities used in for infrastructure projects and manufacturing.

For the annual goal of a growth of 10 percent for China in 2012, China will likely reach it, although economically devastated Europe, along with the weak American economy, make it unlikely China's goal of export growth of 10 percent will be met. Exports are probably going to be more in the 8 or 9 percent range for the country.

Chinese imports should climb in the second half as commodity inventory is used up.

Citigroup (NYSE:C) Building Up Commodity Unit in Europe, Asia

Citigroup Inc. (NYSE:C) said they're increasing the greatest number of commodity jobs for the company in Europe and Asia, as the North America market is considered the most "mature."

Stuart Staley, global commodity head for Citigroup said, “It’s been a leaner year than the past two years across the sector. We’re adding disproportionately to Asia and Europe whereas the U.S. business is the most mature part.”

Growing demand for energy in Asia has caused Citigroup and a number of its competitors to focus on shoring up its commodity units in Asia especially, as the growing middle class now has the disposable income to acquire more energy, generating more demand for natural gas, oil and coal.

Staley said Citigroup has hired close to 30 people in the commodity unit this year, as investors focus more on physical refined products and crude oil. A growing number of investors want to participate in physical transactions instead of commodity futures, he said.

Revenue generated from commodity transactions for Citigroup will be lower than in previous years, Staley concluded.

Goldman (NYSE:GS) Likes Energy, Down on Agriculture

Goldman Sachs Group Inc. (NYSE:GS) said over the next 12 months they see energy as the top performer in the commodity sector, while they view agriculture as the weakest.

Energy is projected to rise at a 27 percent clip, followed by precious metals at 17 percent, and industrial metals at 15 percent. Agriculture on the other hand, is expected to plummet by 10 percent during the same time.

The analysts' report said, "For the more cyclical commodities, oil and copper, while continued indications of more supportive policy in the U.S. and China, better macro data in these key countries, and improving commodity data have pushed prices higher within their respective trading ranges, we continue to expect them to break out to the upside in coming months."

In the short term they do see some agriculture products doing well, as they raised their outlook on raw sugar, cotton, corn and arabica.

Citigroup (NYSE:C): No Estimates on When Enbridge (NYSE:EEP) Pipeline to Restart

A deadline from the Environmental Protection Agency has passed, and the Enbridge (NYSE:EEP) pipeline transporting oil from Canada across the U.S. remains closed.

Consequently, the price of oil soared to its highest level since August 11, increasing $1.59 to $78.04 early in the trading session at the New York Mercantile Exchange.

Citigroup analyst Tim Evans in a note, "The petroleum markets were trading higher in early going Monday, with support coming from a stronger equity market, a weaker U.S. dollar, and ongoing concerns regarding the Enbridge pipeline outage as there were still no estimates on how long the disruption of Midwest crude oil deliveries will last."

Workers are getting ready to cut the section of the pipeline which caused the leak and replace it.

Over 6,000 barrels of oil have leaked from the pipe.

Crude Oil Prices Resume Drop on Continuing Recession

Contrary to media assertions, the recession continues and that is starting to weigh on the price of oil as it dropped to a six-week low on Friday, and will plunge again after the Labor Day weekend.

The problem is the so-called stimulus money is gone, which had masked the real condition of the economy, and that is causing the jobless claims numbers to rise to levels which reflect that, along with the falling manufacturing numbers, as represented by the release of the general economic index by the Federal Reserve Bank of Philadelphia, which showed a plunge of 7.7 percent this month.

Again, while seeming to be a contraction, things are just returning to what they've in reality been since the recession began as the stimulus money effects leave the economy.

The government and Federal Reserve were hoping to buy time through spending the hundreds of billions so the private sector could rebound and take their place as creators of jobs and economic growth.

But the stimulus produced a false signal which had CEOs even hailing the economic turnaround, when they were in fact the beneficiaries of taxpayer dollars, rather than demand from the marketplace.

No matter how you look at it though, we're in for a rough ride economically, as there's nothing out there to indicate we're even close to beginning a recovery, and in fact the failure of government interference is being revealed publicly to all, yet the Federal Reserve has give us their assurance they're ready to do and spend what it takes to shore up the recessionary economy again, which will cause even more devastation over the long term.

Crude oil prices and inventory are predictably responding, as the oil inventory of the U.S. surged to its highest level since 1990, according to an Energy Department report.

That means consumers are staying close to home and continuing to cut back on spending.

When taking into account the fundamentals, crude oil prices are still considered too high, and the possibility of increased demand is falling by the wayside. Nothing indicates that will change anytime soon.

In other ominous and understated economic news, Axel Weber, a council member of the European Central Bank, said the European economy may need intervention from the central bank through the end of 2010. That's not surprising, as there was no way the sovereign debt crisis, which has largely been ignored by the media after it was allegedly taken care of, has been resolved, as the sheer size of the problem couldn't be taken care of with a few debt offerings, no matter what the size of them were.

While the austerity measures taken by some nations were a good move, it staggers the mind to think they could go back to throwing money out into the economy of the region through central banks, making the problem even worse than it is.

With oil prices looking to the economy to signal where things are at, the answer is it's in bad shape, with no prospects it's going to turn around in the near future.

That means consumption, at least in the U.S., the world's largest oil consumer, will continue to fall, and oil prices should follow that lead.

In the peak July traveling season, joblessness and higher gas prices held consumption down, keeping demand relatively unchanged at a time it should have been soaring. Gasoline deliveries even fell slightly from last year, averaging 9.257 million barrels in July 2010, in comparison to 9.26 million in July 2009.

Stockpiles in the U.S. rose to 1.13 billion for the week ending August 13, gaining 5.3 million.

Peter Schiff Bullish on Precious Metals, Oil

Peter Schiff stated recently that while he is heavily invested in gold, he is also bullish on other precious metals, and oil as well.

Specific metals identified by Schiff were platinum and silver, although he added he is also bullish on some industrial metals too.

The Gulf oil accident with BP (NYSP:BP) is particularly noteworthy in Schiff's estimate of oil in general, and he said the costs of offshore drilling will skyrocket, including insurance.

There will also be less oil because of the moratorium in the Gulf, which will decrease production if that isn't changed.

Demand for oil from China is a factor as well. So combining what appears to be increased demand and lower supply, and there is nowhere for oil prices to go but up, in Schiff's view.

Bank of America (NYSE:BAC) Downgrades Concho Resources (NYSE:CXO)

Concho Resources (NYSE:CXO) was downgraded by Bank of America (NYSE:BAC) from "Buy" to "Underperform."

The independent oil and natural gas company was downgraded on valuation, said the giant bank, while the recognize the operational narrative of the company.

Concho engages in the exploration and development of natural gas and oil properties.

At noon PM EDT the stock was at $56.29, down $3.28, or 5.51 percent.

Goldman Sachs (NYSE:GS) Sees Copper, Crude Oil Rising

Goldman Sachs (NYSE:GS) sees copper and crude oil rising by the end of 2010, surprisingly based on what they're saying will be economic growth.

They say copper could increase to as high as $7,755 a metric ton, while crude oil will probably hit $93 a barrel.

“When you look at the underlying fundamentals, whether it’s macroeconomic data or commodity-specific data, the fundamental picture is still very strong,” said Jeffrey Currie. "With copper, the fundamentals are outright rock solid.”

This is an interesting and contrarian viewpoint for the economic conditions we face, and calling the macroeconomic data fundamentals very strong is puzzling to say the least, especially in light of the emerging slowdown in China, which has caught a lot of people off-guard.

One thing to keep in mind with China is they will probably only slow down a little in comparison to past performance, but even a one percent decline in China is quite a huge hit for raw materials companies and others looking to import to the country.

There are too many variables out there to justify this type of optimism, and while there may be some growth, the manufacturing sector is already in retreat, and commodity prices falling along with demand.

BP (NYSE:BP) LA Refinery Closed for Unscheduled Maintenance

A major BP (NYSE:BP) (LON:BP) refinery was closed in the area of Los Angeles today, with the oil company shutting it down for unscheduled maintenance.

The Carson refinery, which produces as high as 6.3 millio gallons for the three-state area of California, Nevada and Arizona, is an fluid catalytic cracking unit, or FCCU, providing gasoline grades required in the area.

A Planned Flaring Event Notification was filed by BP to state regulators in California in reference to an unidentified breakdown at the refinery.

Someone familiar with the matter said the refinery will probably be out of service for 10 days.

Carson has the ability to process as high as 265,000 barrels of oil a day.

We'll probably hear a lot of these types of actions by BP going forward, as they can't afford any type of additional accident in light of the current crisis in the Gulf, and so will probably be cautious to a fault for a long time into the future.