Oil Gets Cheaper - What Would Ben Graham Do?
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In terms of excitement, investing usually rivals watching paint dry. That has not been the case lately.
Let’s start with the good news first. South Korea just reported its lowest daily number of new COVID-19 cases, at 69. This gives hope that the strategy of intensive testing and containment works (South Korea has tested hundreds of thousands of people). It’s also good news that the fatality rate of COVID-19 is likely to be less than 1%, rather than close to 3% as originally feared. This decline is due to wider testing, which increased the denominator. A large number of people who were infected with COVID-19 exhibited only mild symptoms.
Oil gets cheaper
Now to the big, really new news. Saudi Arabia announced that it will increase oil production from 9.7 million barrels a day to 10 million and then to 12 million if needed. This news alone sent the oil price down 20% – and the whole stock market with it.
I understand the market’s reaction, but I don’t view this news as negatively as the market does. Let me explain what Saudi Arabia is trying to achieve.
Saudi Arabia and Russia have had a very cozy relationship over the last few years. Though Russia never officially joined OPEC (the cartel that controls 42% of oil produced globally and that consists mostly of Middle Eastern members), Russia coordinated with OPEC; and thus for a while OPEC became OPEC+ (like Disney+ but less entertaining).
However, over the last few months Russia has had a falling out with OPEC. The coronavirus has brought global travel to an abrupt stop and has thus reduced the demand for oil, while production (supply) has not changed. OPEC wanted to reduce production to stabilize the falling oil price. Russia refused.
We need to understand how both sides view oil. Saudi Arabia views its oil as a large but finite reservoir, and it tries to maximize its value over the long term. Therefore it wants oil prices to be not so high that the global economy is crippled and companies are forced to switch to alternatives, but not too low, either, since the Middle East (with the exception of Israel, which was blessed by not having oil) is a one-trick petrochemical pony. Thus, the Saudis are willing to sacrifice their revenues in the short run (by lowering their production) to increase the value of their oil reservoir in the long run (by keeping supply and demand in balance).