1. They may believe that the unmanaged U.S. supply will continue to drive prices down to the marginal cost of production. If that happens, coupled with improving technology and the repeal of the U.S. ban on oil exports, the price of oil may be set for a long-term downward slide. When you expect prices to decline, it makes sense to sell everything now and get what you can.
This is the supply-side argument, and it would explain the Saudis’ current strategy. Perhaps they simply don’t believe they have, or will have, the dominant market power they enjoyed in the past.
2. They may believe that energy is in a long-term trend away from hydrocarbons. The recent Paris climate accord is one big signpost pointing in that direction, as is the fact that major buyers—China, for example, and Europe—have made massive commitments to renewables. With many renewable energy sources getting close to cost parity, without the externalities of carbon-based fuels, we may be approaching a tipping point, where demand decreases annually rather than increasing.
This is the demand-side argument, and looking at trends in demand, it appears reasonable. Apart from a shift to renewables, we also see economies becoming less energy intensive, meaning that demand can be expected to grow more slowly in any event.
3. Or maybe both. The Saudis don’t have to buy into either argument fully to think that maximizing current revenue may be the optimal strategy. Even if either trend pauses at some point, the fact is that substantial economic forces are poised to drive down oil prices, suggesting that any future appreciation may be limited, at best.
This Time, Prices Just Might Stay Low
This doesn’t mean oil prices will stay low forever, of course. Politics can always intervene, and a war, as I mentioned the other day, could drive prices up in a big way. Long-term, though, the trends do look negative for oil prices on both the supply and demand sides.
In short, for oil, it does seem as if it will be different this time (and the Saudis are certainly acting that way). Could prices continue to drop? And what would that mean? We’ll discuss those questions in the next several posts.
Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation’s largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth’s investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by Brad McMillan.