Lower Oil Prices and the Global Economy

Stock market investors are betting on central banks like the Federal Reserve sparking the global economy back to robust health through monetary policy. However, with interest rates already at zero for all practical purposes, the main weapon remaining in the Fed's arsenal is money printing through quantitative easing and other measures. And the effects of that medicine seems be less and less with every dose given.

But investors should not despair...right now, there is another force at work stimulating economic growth around the globe. What is it? Lower oil prices!

Since March alone, oil prices have declined by more than 30 percent, leaving consumers more spending power. The global benchmark for oil, Brent crude, has tumbled to its lowest level in over 18 months and is now trading below $90 a barrel. Quite a drop from its peak earlier this year at $128.40 per barrel. And that is thanks largely to Saudi Arabia boosting production earlier this year to a 30-year high in effort to help the global economy.

The drop in crude oil prices is a definite negative for investors in the oil patch though. Take a look at three of the large international oil companies – ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX) and BP PLC ADR (NYSE: BP). The stock prices of both Exxon and Chevron have fallen by about 5 percent while BP has tumbled by a double-digit percentage so far in 2012. And their share price is unlikely to rebound strongly in the near future.

The reason? Lower oil and gas prices means lower earnings for these companies. According to FactSet, ExxonMobil is expected to earn $8.09 a share in 2012 versus $8.37 in 2011, Chevron is forecast to earn $12.98 per share in 2012 against $13.28 in 2011, and BP is predicted to earn $6.26 per share in 2012 compared to $6.89 in 2011.

So oil companies look to be losers in 2012 thanks to low oil prices. But there will be winners too. These are the big oil consuming industries such as airline and trucking companies. There is some evidence already that, for example, airlines are benefiting. The airline industry trade group IATA (International Air Transport Association) has hinted that the drop in jet fuel costs has already saved airlines nearly $20 billion (out of a forecast annual $207 billion price tag) in their costs. More evidence of lower oil prices being a boost to earnings in these sectors may become apparent when these firms start reporting results from the April-June quarter in the weeks ahead.

The interesting thing occurring right now in the oil market, which is both good but scary, is the lack of hedging by large oil users like airlines despite the 30 percent drop in oil prices. One would think major users would want to lock in these lower prices. But they are not at the moment.

The chief financial officer at Southwest Airlines (NYSE: LUV) said earlier this year that the company's hedge protection for the second quarter of 2012 was “minimal”. And according to the Financial Times, an executive vice-president at FedEx. Michael Glenn, stated last week that “lower fuel prices will help [his company]”.

But the scary part is that this lack of hedging is eerily reminiscent of 2008 when these companies did not hedge their fuel costs in anticipation of even lower oil prices thanks to growing economic weakness around the globe. They are apparently betting on further economic weakness coming out of Europe and China, the main engine of oil demand.

But the oil price weakness scenario could change rather quickly. Current oil prices are now below what could be called the comfort threshold for most OPEC countries including Saudi Arabia. These countries' budgets have ballooned in the past few years as they have spent on improving their citizens' daily lives because of the fear of widespread unrest as the Arab Spring moves from country to country in that part of the world. It is believed that Saudi Arabia, for example, now needs Brent crude oil to be at around $90 a barrel in order to pay for all the domestic programs they have initiated.

So investors and hedgers should not be surprised if it soon throttles back on oil production. Hopefully, airlines and other big oil consumers will have hedged their exposure to higher prices by then.

This article was originally written for the Motley Fool Blog Network. make sure read all of my daily articles for the Motley Fool at http://blogs.fool.com/tdalmoe/.

The Outlook for Oil Prices in 2012

2011 was a relatively stable year for oil prices. Brent crude oil traded in a narrow band all year between $100 and $120 a barrel. But 2012 may be a very different year with traders bracing themselves for a much rougher ride.

The base case scenario is for oil to remain at about $100 a barrel in 2012. This is founded on relatively healthy oil demand growth of about 1 million to 1.2 million barrels a day in 2012. This outlook also is based on OPEC maintaining its output at the current 3-year high of around 30 million barrels a day and the end of supply disruptions that troubled the oil market in places like Libya.

And indeed, at its recent meeting, OPEC did set a target for output at 30 million barrels a day.

However, despite the apparent calmness in the oil market, there is currently an extreme difference of opinions between the bulls and the bears on oil prices in 2012.

There are traders on opposite sides of the market who are buying large amounts of out-of-the-money oil futures option contracts that would profit from both a collapse in oil prices and a super-spike. These traders are betting on low probability events – either a rise to $150 a barrel for oil caused by Middle East unrest or a drop to $50 a barrel brought about by a eurozone collapse.

The key benchmark Brent crude oil contract is now trading for approximately $108 a barrel.

Although there are bets occurring on both sides, recent options buying on the New York Mercantile Exchange has been skewed toward an upward spike for oil based on risks coming from a possible European Union embargo on Iranian oil.

Since October, many trading firms have noticed persistent interest in call options for prices ranging from $120 to $180 a barrel. The number of options contracts purchased betting on a move for oil to $130-$155 a barrel by the end of 2012 has risen more than 25% over the past six months to more than 93,500 contracts.

These buyers perceive greater geopolitical risk than just the situation with Iran and its nuclear program. There is also the threat of regional war if Syria were to collapse or even a turn for the worse politically in Egypt or Libya.

Finally, there is even the risk that political turmoil in Russia surrounding the presidential election in March may disrupt output from the world's second-biggest oil producer.

But the bears have their reasons too. They say a eurozone collapse will trigger a worldwide recession that cuts oil demand sharply. The global financial crisis of 2008-09 did see two consecutive years of falling consumption for the first time since the 1980s. This did drive oil prices briefly below $40 a barrel, forcing OPEC to cut production.

Bears also point to a hoped for increase in Iraqi oil production of at least 500,000 barrels by the middle of 2012 as well increased U.S. shale oil production from North Dakota and Texas.

Both bulls and bears could be right depending on if one of these 'low probability' events comes to pass. Either way, 2012 looks to be a far more interesting year for the oil market than 2011 was.

Individual investors can join in with professionals on trading the perceived upcoming volatility in oil prices through the use of exchange traded funds.

Some of ETFs available for purchase include: United States Oil Fund (NYSE: USO), United States Brent Oil Fund (NYSE: BNO) and United States Short Oil Fund (NYSE: DNO).

Article originally written for the Motley Fool Blog Network. Check out my articles there at: http://blogs.fool.com/tralmoe/

Arab Spring Drives Up Oil Prices

The United Arab Emirates' oil minister, Mohammed Al Hamli. recently defined a “reasonable” price for as oil as between $80 and $100 a barrel. This is quite a jump up from just five years ago when OPEC oil ministers said that a “reasonable” price for oil was about $50 a barrel.

But a look at the price that Middle East countries need to survive economically today explains why oil ministers are now targeting such higher prices.

Not long ago the International Monetary Fund provided a timely update on the so-called 'breakeven price' for oil needed by Middle East producers to balance their fiscal budgets.

In the IMF's latest semi-annual “Regional Economic Outlook: Middle East and Central Asia” report, it estimates that the breakeven oil price for the UAE has now risen about $80 a barrel, up from $60 a barrel in 2008.

For Saudi Arabia, the IMF estimates that $80 a barrel is the breakeven price, up nearly $30 a barrel in just three years.

Part of this increase in the breakeven price can be explained by the sharp increase in spending earlier this year in response to the 'Arab Spring'.

But even before 'Arab Spring', budgets in Middle East countries were ballooning nearly out of control as governments try to deal with little non-oil revenues, rapid population growth and a very generous welfare system where governments pay almost everything for their citizens. These include payments for utilities, fuel, education, housing and health.

The rapid rise in breakeven oil prices means that key members of OPEC now have a strong incentive to defend much higher prices.

It also means that Middle East countries are unlikely to spend any large amounts of money in building spare oil production capacity. This is simply no money in their budgets for such undertakings.

The bottom line for investors and consumers is that oil prices would be extremely unlikely to below $80 a barrel for more than a brief period of time.

This is obviously bullish for oil. Investors can participate easily through the use of an exchange traded fund. The ETF which best reflects global oil prices the United States Brent Oil Fund (NYSE: BNO).

The Importance of Angola to the Oil Market

Libya has been at the forefront of oil investors for much of the year. The nation of Angola has also been a source of supply disruptions in 2011, helping push crude oil prices higher.

Angola has been a true success story. Over the last decade, it more than doubled its production. Output rose from 750,000 barrels a day in 2001 to a peak of nearly 2 million barrels a day in January 2010.

The bad news for the global oil market is that the west African country, which joined OPEC in 2007, has seen its output fall significantly this year.

In 2010, Angola pumped an average of 1.85 million barrels of oil per day. But in 2011, it has managed to pump out just an average of 1.65 million barrels a day of oil.

Investors may shrug their shoulders and say 'so what?'. After global oil production is roughly 87 million barrels a day and Angola producers about 2 percent of that total.

However, Angola is far more important to the global oil market than appears at first glance.

Angola pumps a particularly low-sulfur crude, which is highly sought after by Chinese and Indian refineries to produce high quality gasoline and diesel.

China bought about 45 percent of the country's oil production last year. The United States and India are the next two biggest buyers, accounting for another third of Angola's oil exports.

So the global oil market has looked with interest as Angola's oil production stalled due to a lack of new projects and glitches in several existing oil fields. There were technical problems (water injection among others) in the Saxi-Batuque field operated by ExxonMobil (NYSE:BP) and the Greater Plutino field operated by BP PLC ADR (NYSE: BP).

The good news now is that the production problems are being solved. In addition, new oil fields are coming onstream.

The Plazflor field, operated by France's Total SA ADR (NYSE: TOT), will add 200,000 barrels of output while several projects from BP will bring another 150,000 barrels online. Additionally, Exxon's Kizomba-D cluster fields will add on another 150,000 barrels a day.

In total, Angolan production capacity should recover by 400,000 barrels a day year-on-year, alleviating some pressure off high oil prices which is good news for consumers.

Oil Companies' Production Lags

The world's biggest oil companies, such as ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX) and ConocoPhillips (NYSE: COP), are flush with cash.

So all looks well for the oil industry...but it is not.

If investors drill beneath the surface, they will see these companies are stagnating when it comes to their oil production. ExxonMobil, for example, reported that in the third quarter its oil production fell 4 percent to 4.282 billion barrels of oil per day.

This trend though is hardly new and points to a long-term challenge for the industry.

Paul Cheng, senior analyst in the US for BarCap, said “The supply outlook for global oil production for the next 12 months is challenging.” He expects “very slow growth, if any” from the major oil companies through 2012-2013 “at least”.

A study of oil production for the 2011 second quarter for 40 large oil companies in the OECD countries showed an average year-on-year drop in production of 8 percent. And this was despite the incentive of high oil prices – Brent crude oil averaged about $120 a barrel.

There are two macro trends which account for this poor performance from the oil companies.

The first is that a lot of the oil recently discovered has been in difficult and expensive to access areas...areas such as the deep water areas of the Gulf of Mexico and offshore western Africa.

Another issue is the lack of investment by the major oil firms. Companies like Exxon have been notorious for underestimating the price of oil. Their assumptions on the oil price have not been aggressive enough in order to justify their spending additional funds on exploration.

In the words of Mr. Cheng, “They [oil firms]did not plan for sustained $100 per barrel plus Brent [oil].”

This may all change, of course, if the industry proceeds full speed ahead over the next five years with development of shale oil in the United States.

But the environmentalists may have a lot to say about that.

The New Oil Dynamics

The oil market changed back in 2009, but most Americans did not notice.

That was the year, for the first time, China temporarily surpassed the United States as Saudi Arabia's biggest and most important customer.

At the time, Saudi oil minister Ali Naimi said “Ten years ago, China imported relatively little crude oil from us. Now, it is one of our top three markets, and is the fastest growing market for us globally.” He added that this showed the increasing “depth of Saudi-Chinese relations”.

Today, when oil tankers leave Saudi ports with their load of crude oil, they increasingly travel eastward to the rapidly growing economies of Asia rather than to the established markets of western nations.

When looked at historically, this new trend is significant. Remember that the most of the oil industries in the Middle East were originally set up by western companies with the sole aim of providing oil for western economies.

The day when Saudi oil exports to China permanently overtake those to the U.S. has not arrived yet. But it will soon.

Saudi Arabia is also selling more oil to that other Asian economic giant, India. Saudi crude exports to India grew sevenfold between 2000 and 2008. The desert kingdom now provides about a quarter of India's oil.

Meanwhile, total demand for oil in the U.S. and Europe is flat at best.

The changing oil dynamics, however, is not a simple story. It's getting more complicated.

Look at Saudi Arabia. It has its own rapidly growing economy and is consuming more of its own oil. The kingdom consumed 3.18 million barrels of oil per day in the third quarter of 2011. This is only a bit less than the 3.25 million barrels of oil per day used by India during the same time frame.

Bottom line...roughly a third of Saudi Arabia's 9.8 million barrels of oil per day production last month was absorbed by domestic consumption. This means less and less oil is available to sell overseas.

Taken together with increased demand from Asia, it means higher prices for oil down the road for American consumers.