Daniel Yergin is to oil what Seth Klarman is to stock Picking. I hold each of them in high esteem for being experts in their respective worlds. Mr. Yergin is a Pulitzer Prize winning author for his history of the petroleum industry from 1850 through 1990. Reviews call his book “The Prize” a “bible” and the definitive history of the oil industry. Mr. Yergin did a follow up in 2011 call “The Quest”. Having learned most of my oil facts from Jed Clampett on the Beverly Hillbillies and JR Ewing on Dallas, I found “The Quest” to be almost as entertaining as watching Elly May Clampett “rassle” with brother Jethro.
When Mr. Jergin’s name recently appeared in the Heard on the Street section of the Wall Street Journal, I immediately clicked on the story. Mr. Yergin says it is still all about Saudi Arabia. Given that one out of eight barrels of oil are pumped from the Kingdom, the battle for market share (with a currency war as the side show) was definitely won by Deputy Crown prince Mohammed bin Salman, grandson of the country’s founder. The precipitous drop in oil to a market clearing price of $26 a barrel in February spooked investors and lenders, put a halt to new investment and shut down marginal producers. Mr. Yergin cites his own company statistics that show 2015 to be the lowest investment year for oil since 1952. Mr. Yergin sees the current mid $40 price as a signal that the market is turning. However, he is quick to caution that production still exceeds demand and there are still big surpluses in oil inventories. He believes that by 2020 demand for crude will exceed current supply by more than 5 million barrels a day. The winners from this predicted change will be the nimble and low cost producers whom he identifies as Saudi, the Middle East and new shale production.
Unlike prior episodes of Oil Chicken, Saudi is determined to diversify away from oil as its only resource. It is intending to develop a massive sovereign wealth fund to reenergize an economy with 11% unemployment, principally among young people who may be swayed by jihadist sentiment. Saudi recently announced a $3.5 Billion investment in Uber. It also plans to continue investing in the world’s third largest military. As a financier and a geopolitical force, the new Saudi will be reinvented. The IPO of Saudi Aramco will be a signature statement.
The only exogenous variable in the playbook is the U.S. Dollar. Right now a strong dollar challenges a $50 target. Recently the U.S. Dollar weakened with a great benefit to the price of oil. With the rest of the world’s monetary policy faltering around the negative interest rate stimulus and the spotlight on a China recovery that may be sputtering, the U.S. Dollar may reverse its trend and strengthen.
While I cannot understand why $30/BBL oil isn’t better for the citizens of the world than $50/BBL I do understand that business interests and oil producing countries need petrodollars to pay off leverage. I also understand that since oil is priced in US Dollars the prosperity equation is often in disequilibrium. We need a strong US economy for jobs at home but a relatively weaker currency for exports. We need a high oil price for those leveraged producers teetering on bankruptcy but we need a low pump price for consumers. I guess Saudi will end the debate with its decision on production. As the low cost producer it can pretty much set its own funding plan for the planned sovereign wealth fund and the IPO of Aramco. It is so interesting to see other nations play Chicken with the U.S. and win. Saudi joins a long list of emboldened competitors including ISIS, Putin, Kim Jong UN, the Taliban and Al Qaeda all of whom have flourished as America becomes less exceptional in the eyes of its ruling class.
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