A shock wave of epic proportions just hit the global energy sector.
It involves a startling new development in China’s oil market that no one saw coming…
Yet it promises to have a profound impact on the industry going forward.
Here’s a quick breakdown of what’s happening, along with a plan of action to ensure that you’re protected from any potential fallout…
Oil Prices Poised for Death Spiral
China is a huge player in the global oil market – second only to the United States.
And with demand approaching 10 million barrels per day (bpd), everyone thought that demand was growing, not shrinking.
As it turns out, that wasn’t the case…
According to Platts, a very well-respected industry source, demand for oil in China actually fell to 9.61 million bpd in July.
That’s down 2.1% from a year ago, and a whopping 6.2% from June.
In fact, China is now a net exporter of oil products, shipping out nearly 5 million gallons per day of surplus fuel in the form of gasoline and heating oil.
This is huge news.
We already knew that oil prices were headed lower, thanks to increased U.S. production, subdued growth in the EU, less usage in the United States, and the continued shift toward natural gas.
But decreased usage in China will have a major effect on the resource.
The Danger of Low, Low Prices
Of course, the upside for the rest of the world is lower gasoline prices. This past Labor Day Weekend, the United States registered the lowest price per gallon in four years!
This is great for the United States. Low gas prices act as a de facto tax cut that feeds into an economy still in the midst of a choppy recovery.
If prices continue to drift lower, though, it will dampen the revenue and earnings of big shale plays that already operate at tighter margins than conventional producers.
Ultimately, despite major and ongoing geopolitical events that historically raise prices, the price of oil could reach $80 per barrel.
So is it time to bail on oil altogether?
Where to Look Next
Not exactly…
Global demand is still stable, and the Indian economy is beginning to pick up. This is significant because India is a major importer of oil.
Investors should look to lower-cost oil production sources and companies that bought into shale plays at low prices, like Pioneer Natural Resources (NYSE:PXD).
Even bigger conventional producers – like Statoil (NYSE:STO) and BP (NYSE:BP), which has seen its share price move lower as a result of unrest in Russia and continuing issues related to the Gulf of Mexico oil spill – don’t need to be shunned completely.
It’s also time to look at companies that are operating in regions where the cost benefit is improving, like the Permian Basin. Horizontal drilling in the shale-rich Permian is showing signs of great success as drilling horizontally allows for greater recovery over a fixed area.
Oil isn’t dead, not by a long shot. But pricing dynamics are now being affected by economic events outside the United States for the first time.
That is something that bears watching.
And “the chase” continues,
Karim Rahemtulla