There is a major false belief about the oil industry that’s held by most of the public and only serves to get you to buy crude over a longer period. That belief: Oil companies and organizations like OPEC want crude prices to be as high as possible.
That’s simply not true. And, over the weekend, Saudi Arabia’s energy minister gave us some evidence of that.
This morning, Reuters reported that Saudi Arabia’s Minister of Energy Prince Abdulaziz bin Salman Al-Saud wants “sustainable” oil prices and growth in demand. The media outlet writes:
Prince Abdulaziz bin Salman said it was too early to talk about whether the Organization of the Petroleum Exporting Countries (OPEC) and its allies, a group known as OPEC+, would continue with production curbs agreed under a deal that expires in March.
“As tension remains high in our region, Saudi Arabia will continue to do all it can do to ensure stable oil markets,” the minister told an energy conference.
“We would like to have a stable oil market, sustainable growth in terms of demand, sustainable growth in terms of supply,” he said, adding that both high and low prices were undesirable.
Anyone can understand why OPEC doesn’t want oil prices too low. If market prices are too low, there’s no profit. But what happens if oil prices are too high?
The uninitiated tend to believe oil prices can’t be too high for OPEC — the higher the prices, the higher the profit, right?
Well, yes, but here’s the problem: That won’t last long.
Fact is, there are alternatives to oil. If the price of oil gets way too high, those alternatives become competitive. That’s what OPEC wants to avoid.
Back in 2008, OPEC learned its lesson about this. From the 1980s to 2000, the price of oil didn’t change much. It was pretty much stable. But, starting in 2000, oil prices began to sharply rise, peaking at over $100 per barrel in 2008.
It was a helluva time to be OPEC. The money was pouring in, but the market reacted.
As oil prices increased at the start of the new millennium, alternatives like solar, wind, and electric became more competitive. This led to a sharp increase in energy alternative investments, which also lead to a sharp increase in efficiency for energy alternatives. I’d even argue that $100 oil and the subsequent increased interest in energy alternatives is mostly responsible for the renewed climate change debate.
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So while $100 oil was great for OPEC in the short term, it also led to the faster development and implementation of crude alternatives.
But that wasn’t the only problem OPEC had by allowing oil prices to soar during that time. $100 oil also allowed for the development of the fracking industry in the United States. As a result, the United States has become the world’s largest producer of oil.
So, by allowing oil prices to get out of hand, OPEC created its own competition from oil alternatives and resources that were previously uneconomical to exploit. They screwed themselves.
Now that they’ve learned that lesson, OPEC wants “sustainable” oil prices. What OPEC means is it wants oil prices to trade in a range — not too high, but not too low. I estimate this range is between $50 and $75 per barrel.
So if OPEC is actively working to keep oil within this range, it’s unlikely the price of oil is going back to $100 anytime soon.
However (and this is very important), none of this means you shouldn’t invest in the oil industry.
Investing is not playing the lottery. From my experience, most new investors are looking to buy a $0.50 stock hoping it will go to several hundred dollars a share. Of course, that does happen sometimes, but it’s not often. If it were often, everyone and their pet goldfish would invest all the time.
And, ultimately, seeking a massive return from anything isn’t “investing;” it’s speculating. According to investing legend Benjamin Graham, an investment operation is one that seeks an “adequate return.” In his seminal work, The Intelligent Investor, Graham writes:
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
Investing is a game of yards. It’s not a home run derby. So even though it’s unlikely oil is going back to $100 anytime soon, there are still great reasons to invest.
In fact, you could argue that $100 oil is bad for oil investors (unless they’re sellers, which wouldn’t make them investors anymore) because that would give alternatives another boost in popularity.
Bottom line is if you’re an oil investor, you should want crude to trade within a range. If you’re an oil speculator, then, sure, you want to see $100 oil. But for long-term holders (a.k.a. real investors, not gamblers), crude staying within a certain range will produce higher returns than if oil prices skyrocketed.
By keeping oil prices at a reasonable level, OPEC and oil companies sustain themselves by forcing the market to continue buying crude over a longer period of time. And that’s why even though oil probably won’t see $100 in the short term, you should still be an oil investor.
Until next time,
Luke Burgess
As an editor at Energy and Capital, Luke’s analysis and market research reach hundreds of thousands of investors every day. Luke is also a contributing editor of Angel Publishing’s Bull and Bust Report newsletter. There, he helps investors in leveraging the future supply-demand imbalance that he believes could be key to a cyclical upswing in the hard asset markets. For more on Luke, go to his editor’s page.
