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Oil Prices Rebound…but not a True Recovery

 

 

Nathan McDonald for Sprott Money

 

 

Three consecutive days of oil prices rising and suddenly all is well again. This is the extremely short sightedness that the markets possess. The bottom callers have come out in droves, screaming that prices will only move higher from here, but will they?

There is a possibility that oil prices may of hit a near term low, and will likely stabilize in the $40 to $45 per barrel range. However, the reasons for the recent rise in oil prices that market pundits have been expressing are simply not true.

Reality cannot be ignored. The economy is not getting better and this year continues to go from bad to worse. Low oil prices are taking a heavy toll on the shale industry in the United States. It has decimated the Russian economy, and now the Canadian economy is showing signs of extreme stress, especially in its overpriced housing sector.

Oil prices rebounding in the short-term, as with any market in the short term, means little to nothing. The long-term effect is what matters.

Regardless of this rebound, I do believe that oil prices will ultimately move much higher. Perhaps not anytime soon to the inflated levels previously seen, but nonetheless higher.

This won’t be driven by a recovering economy, which is still reeling from the same sickness brought on by the 2008 economic crisis. There is too much debt. The one thing and one thing alone will move oil prices higher…is low prices.

As I’ve stated before, the best cure for low prices in the commodities market is low prices. Low prices force shutdowns and closures of mines, pumps, drilling, you name it. A company will not simply extract a valuable commodity from the ground, just to sell it at a loss.

OPEC knows this. They also know that by depressing prices to these extreme lows, companies will be forced to stop production, layoffs will commence and companies will take many years before they dive back into costly projects with both feet.

OPEC appears to be taking a lesson right out of the Chinese playbook, when it decimated the rare earth market, crashing prices and destroying companies in the process. This enabled them to accumulate a purported 97% dominance in the industry.

OPEC officials are confident that we haven’t seen the lowest of lows yet, stating that prices could drop to the $30-$35 per barrel range, before moving higher. Although this price would hurt the wallets of OPEC participants themselves, in the end it will help them achieve their end goal of thinning out the herd in the oil industry.

In a recent Reuters interview, one OPEC official had the following to say:

“The general feeling is that prices will still remain lower than what we all want because of the excess of supply in the market. The expectation is that these stocks will not decrease before the first half of the year.”

“There are a number of good signs, for example the shutdown of some production in the U.S. and Canada. So it means that the policy decision made in the last meeting was the correct one, it’ll be slow, painful for some more than others but in the end effective,”

One country this official fails to mention is Russia, which I’ve maintained is the main target in this oil price takedown. I still believe that the United States has taken this assault on one of their only booming industries, with little resistance from the Russians.

Regardless of this omission, the facts remain. Oil prices will only move higher once supply has been drastically reduced by a wide-scale shutdown of costly oil producers, which will result in an economy weakened by layoffs, loss of income, and an industry that will take many years to fully recover.

OPEC and those companies large enough to weather the storm, will then be the direct beneficiaries of an industry that has less competition and steadily increasing prices. A win-win scenario for them, and lose-lose situation for us.

 

Nathan McDonald for Sprott Money