This is Why Oil is Back Above $75

By: Keith Kaplan

Jul 06, 2021 | Educational

Last week, we kicked off the second half of 2021.

And there was no commodity followed more closely than oil.

On Friday, West Texas Intermediate (WTI) crude futures prices finished the week above $75.

That was the highest price that WTI crude oil has traded since 2018.

That is also a huge reversal from early 2020 when oil futures prices crashed into negative territory.

Today, I want to explain why oil prices continue to rise and what to expect in the second half of the year. But, most importantly, we’ll check in on a few names that hit our watch list back when oil prices were trading under $70 per barrel.

Checking In with OPEC

Crude prices moved higher this week after the Organization of the Petroleum Exporting Countries (OPEC) and allies delayed their meeting on global oil production. OPEC and its allies have the nickname of OPEC+, and these global nations act as a cartel to control the global price of oil.

That’s perfectly legal. In game theory, there is a focus on cooperation and not competition.

In the case of OPEC, nations like Saudi Arabia, Iraq, Libya, and the United Arab Emirates gather to discuss how much crude each nation will aim to produce and export in a given time frame. They produce about 40% of the oil in the world.

Their exports represent roughly 60% of the crude that is traded around the world each day. They also have nearly 80% of all proven oil reserves under their control.

So, they have incredible influence.

The goal of their meetings is to ensure that they control the flow of production to meet global demand.

Last year, after COVID struck, oil prices plunged due to concerns that global demand would fall. As a result, OPEC elected to cut production by a large amount to balance out global markets’ supply-and-demand equation.

Each of these nations relies heavily on crude oil production to fund their government balance sheets. This includes – but is not limited to – social budgets for education, welfare, food subsidies, and more.

So, why would any of them agree to cut their own production in agreement with other nations?

If a country could produce 5 million barrels and receive $50 on the oil markets or 4.5 million barrels and receive $65, which one is the better deal?

In scenario one, the nation would generate $250 million in revenue.

In scenario two, where they agree to cut and control production alongside other producing nations, they help control supply and increase the price. As a result, they would generate $292.5 million.

That’s a 17% bump in revenue.

So, when you see OPEC has decided to curb production or reduce the amount they could produce, keep in mind they are doing so to help elevate global oil prices to benefit themselves.

The Impact on Prices

Given OPEC’s immense reach and influence, this cartel impacts the price of crude oil worldwide. But one of the interesting elements of their efforts to control prices is that demand continues to rise as economies reopen.

OPEC is not willing to turn the taps on completely just yet. With nations increasingly concerned about new variants of COVID-19, the cartel wants to wait and see if this global recovery continues or slows down. In a scenario where the economy accelerates, Goldman Sachs says that there could be a global oil deficit of 5 million barrels per day.

Goldman has suggested that oil prices could hit $80 at the end of the year. However, several energy executives suggested that oil prices could rise as high as $100 by the end of the year.

By that point, however, many other producers would likely hurry to produce as much oil as possible. Those producers include many OPEC nations and their allies like Russia.

There is a saying that the cure for rising commodity prices is rising commodity prices. This means that when prices are high, companies will produce more of a specific commodity. As a result, we eventually can see a glut of this commodity. In this case, oil prices might retreat quickly and rebalance to levels that we saw before the pandemic began.

How to Ride Higher Oil Prices

Remember, at TradeSmith, we’re always looking to generate high income and achieve a higher price upside on every stock we buy.

For those reasons, we recommend two ways to play the rising price of oil. First, we are looking for oil production companies. These companies own vast reserves of crude oil and sell it on the market. When the price of oil rises, so does the value of its assets on the balance sheet.

Companies like ConocoPhillips (COP) and Marathon Oil (MRO) sit in the Green Zone and maintain uptrend momentum. These companies had a solid June and will look for more appreciation should oil prices continue to rise.

Meanwhile, you know that we also like Master Limited Partnerships or MLPs. These generate huge amounts of dividends. For a primer, click here.

Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP), and MPLX (MPLX) remain our favorite plays in this energy space.

All three provide dividends north of 7.4%, trade in the Green Zone on TradeSmith Finance, and remain in an uptrend momentum to start July.

I’ll be back tomorrow with insight on the major risks facing the global markets and the global opportunities. I hope you had a wonderful holiday weekend.

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