How Oil Is Tanking the Market

Thursday’s indiscriminate sell-off was followed by markets in Asia and Europe, with the dour mood coming full circle into today’s session as well. Hard to tell whether this pullback has the potential to morph into the long-feared correction, but the sharp slide in the oil market has taken everybody by surprise, yours truly included. The oil market is the focus of this morning’s note.

There are good fundamental reasons for oil prices to be trending lower. On the supply side of the equation, we had a quiet hurricane season in the U.S. and some of the disrupted volumes from Libya, Iraq, the North Sea and elsewhere have recently come back online. Importantly, the shale oil boom has pushed U.S. production to its highest level since the early 1970’s.

On the demand side, the world will be consuming more oil this year and next, but the growth rate is coming down as a result of weak economic growth in Europe and China. Demand growth in the U.S. is decelerating not because of economic issues, but as a result of a more efficient transportation fleet and general conservation policies. On top of all this is the strengthening U.S. dollar, the primary denomination currency for the global oil markets.

[Hear: Jim Puplava's Big Picture: Trouble in the Oil Patch]

We have to keep in mind, however, that fundamental forces tend to be self-correcting in the long run. Take for example the growing U.S. oil production from shale basins like the Bakken. Relative to other oil producing regions of the world — even the more conventional basins in the U.S. — shale oil is very expensive to produce. Exact numbers are hard to come by, but the ‘all-in’ finding and development cost of producing from the Bakken shale has got to be in the $60 to $80 per barrel range (‘all in’ costs include cash expenses as well as exploration and development related capitalized costs). Keep in mind that comparable unit costs in the Middle East are about a quarter of these levels and somewhere in the middle elsewhere in the world.

What this means is that the recent slide in oil prices has already put marginal Bakken producers on the edge and will likely show many mainstream producers questioning their capital plans for the region. Given this, it is no surprise that Bakken-focused E&P operators like Continental Resources (CLR), Whiting Petroleum (WLL) and even some of the diversified majors like EOG Resources (EOG) have been hit particularly hard lately. Given the role of Bakken producers as the marginal suppliers to the U.S. market, I would be very surprised to see oil prices maintain their recent downslide.

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