Trough oil: time to buy the black stuff

    14 November 2015

    Right, here goes. I’m saying it. Now is the time to buy the black stuff. Yes, I know — people who watch oil closely have lost fortunes making the same call in recent months. The price of crude has slumped and slumped, from $100 a barrel in June last year to $45 in mid-October this year. Traders say we’re entering a ‘new era’ for this once–precious commodity, and now it’s anybody guess how and when oil will bottom out. Warren Buffett dumped his Exxon shares in September, and he tends to get the big calls right, doesn’t he?

    But this column is not for experts. Inexpertise is the speculator’s friend. It is true that what they call the fundamentals of global oil production have changed, but oil still makes the world economy go round, and there are reasons to think that we’ve hit the oil-price floor.

    Let’s look at those fundamentals. America’s shale revolution is generally credited with driving down the price of oil. The development of US shale has boosted global output by four million barrels a day — about the same as the combined output of Kuwait and the United Arab Emirates. Combined with sharp slowdowns in gas-guzzling China and other emerging markets, and the imminent lifting of international sanctions against Iran, this has put severe downward pressure on the oil price. Opec, the once all-powerful cartel, has had to accept that with Russia and the US now two of the top three oil–producers (the other being Opec leader Saudi Arabia), it cannot drive up the price by restricting supply in the way it once did.

    The Saudis — now ruled by Salman bin Abdulaziz al-Saud, a more aggressive figure than his brother the late King Abdullah (RIP) — responded by starting an oil war, flooding the market with cheap oil in an attempt to push out the more expensively produced stuff from North Dakota. This dramatic global picture — on top of forecasts from the International Energy Agency of a drop in oil demand in early 2016 — led analysts to be ever more bearish on black gold. Goldman Sachs issued a warning that the price might fall as low as $20 dollars a barrel. Remember ‘Peak Oil’ — the late 20th century idea that oil production would fail to keep up with demand? Forget it. We should start talking about Trough Oil.

    It’s worth remembering, however, how wrong Goldman have been on oil. In 2008, the firm predicted a ‘demand shock’ was about to drive up the price of crude to $200 dollars a barrel. Cue the economic crisis — and an oil-price fall to about the level it is now. But it’s also worth noting that, in the grip of that global panic seven years ago, oil didn’t go below $40 a barrel. Even given the massive increase in production and the growing fears about another great dip, capitalism is not in a comparable state of emergency today. Global oil demand may be expected to slow down next year, but that follows a five-year peak of 1.8 million barrels a day in 2015.

    Meanwhile, the Saudis are in danger of bankrupting themselves as they try to put US shale producers out of business. According to the IMF, Saudi Arabia’s fiscal deficit could rise to around $140 billion by the end of this year. Even the House of Saud can’t keep up that sort of overspending for long. But that’s not necessarily bad news for oil bulls. A slight uptick in oil in October suggests that the Saudis’ out-pumping strategy might finally be paying off. In the longer term, moreover, the erratic behaviour of the Saudi royals suggests they might be losing their grip.

    Bring on the Saudi revolution, I say! Any political upheaval in the world’s least-loved country would slow down the Saudi oil industry. Consider that, plus the desperate urge of many US politicians to bring back sanctions against Iran as soon as President Obama leaves office, plus the growing instability across the Middle East, and it becomes hard to imagine that this new age of oil abundance will endure. It’s still a punt — little more than a hunch, in fact — so my advice would be go small and go risky. Why not take out a Leveraged Exchange Traded Fund on Brent Crude? You can easily set one up through an online share trader — I invested in the Commodity Securities Daily Leveraged Brent Crude (LBRT) fund through Hargreaves Lansdown, although I had to click-sign a couple of warning forms to say I realised this was a ‘sophisticated product’. My LBRT is meant to be leveraged at 200 per cent, so it should return roughly twice the gain or loss of the base price of Brent Crude. You either win big or lose big. Don’t say I didn’t warn you.