The OPEC has had its June 2nd meeting and the cartel has once again failed to come to an agreement to limit oil production. No consensus was expected except for a brief moment just before the meeting. The cartel did discuss a proposal floated by the new Saudi Arabian energy minister, Khalid al-Falih, that would limit OPEC oil output to between 31.8 and 32.5 million barrels per day (bpd). The dysfunctional group couldn’t even agree to this very minimal drop in production. OPEC is currently pumping 32.77 million bpd. Despite the bearish news of no change in policy, WTI crude oil actually went up on the day, rising 0.3% to $49.17. By the end of the week, it was down 1.4%, but this was after experiencing sizable gains the previous three weeks.

Oil Has Consistently Rallied Since February 2016

While OPEC is pumping full speed ahead, U.S. oil production is estimated to be down approximately 500,000 bpd since its peak in April 2015. Moreover, market supply for non-OPEC members is now predicted to be lower by 740,000 barrels per day in 2016. Unusually low prices are responsible for this, but the 20% reduction in global exploration and production spending in 2015 is going to make matters worse going forward. A further 15% drop in spending to keep production up is anticipated this year. At the same time, global oil consumption has grown on average 1.6 million bpd each year since the Credit Crisis bottom in 2009. Lower crude prices have fed the above trend growth by users (and will continue to do so as long as crude prices remain below historical norms).

Most analysts and commentators have been continually negative about oil prices since the low of $26.21 on the NYMEX WTI futures contract on February 11th. Now, in early June, the price of oil has almost doubled. Most of the same voices continue to call a top in the price (similar things happened in the spring of 2009 after oil rose off its low in February, beginning a powerful and long-lasting rally that eventually took it to over $100 a barrel). The recent big drop in oil prices that began in 2014 is by no means historically unique. There was an even bigger percentage drop in 2008-09, and major price drops in 2000-01, 1990-91 and 1985-86. Oil is prone to large up and down price swings. At each major drop, the doom-and-gloomers came out of the woodwork and predicted that the price low was the new permanent state of the market. It never was, and it won’t be this time either. Oil prices always shoot back up and eventually go much higher.

The temporary glut in the market that began in 2014 is actually the result of increased oil pumping from Saudi Arabia and its Gulf state neighbors. Collectively, they’ve increased their oil output by approximately four million bpd since 2010 (for more about this, see here). This strategy is not without considerable risk to their future production. Most oil fields in the Middle East are in advanced old age by industry standards. The giant Ghawar field in Saudi Arabia, responsible for half of all Saudi oil production over time, has been producing since 1951 or for 65 years. This is far more elderly than a human being of an equivalent number of years. Old oil fields that are overworked can experience something called “field collapse,” where production drops significantly without warning and stays much lower thereafter.

Surge in Middle East Production Has Caused the Current Oil Glut

A more common danger is that speeding up production just depletes oil reserves faster and production goes into a steady, irreversible decline. This happened in the Cantarell oil field in the Gulf of Mexico. Cantarell, which only came online in 1981, was once the second largest producing oil field in the world (after Ghawar). At the suggestion of the U.S., its Mexican owner, Pemex, utilized technology that made it possible to pump out oil faster. Production peaked at 2.1 million bpd in 2003. It then dropped continually for more than a decade and by 2014 was only 340,000 bpd. Currently, Pemex is spending billions of dollars to prevent it from falling even further. Faster output didn’t mean additional output, it only meant a large drop in production a few years down the road. Currently, the much, much older oil fields of the Middle East are susceptible to the same fate.

The rate of conventional oil production that has been taking place in the last couple of years is not sustainable. It is happening because every effort has been made to push production to the max. Technology can always be used to ramp up production temporarily, but the cost will be lower than trend production later on. Increasingly larger amounts of funding will be needed to slow the rate of the upcoming decline. That funding, however, was reduced in 2015 and will be lower this year as well. With Iranian production coming back to market after the lifting of sanctions, global oil production has little room to move higher. It does have a lot of room to move lower, though, in 2017 and even 2018. Despite media reports to the contrary, demand keeps growing at a rapid clip (annual global oil demand almost never decreases). This makes the supply/demand picture very bullish for rising oil prices.

Investors can use ETFs to take positions in oil and oil stocks. Investors can participate in the rally by buying ETFs for the commodity, such as: USO, OIL, DBO and USL. ETFs for oil stocks are: XOP, OIH, IEO, IEZ, XES and PXJ. Investors who want to buy individual stocks can consider: Exxon Mobil (NYSE:XOM), Imperial Oil (NYSEMKT:IMO), PetroChina (NYSE:PTR), Royal Dutch Shell (NYSE:RDS.A), Sasol (NYSE:SSL), Statoil (NYSE:STO), Suncor (NYSE:SU) and Total (NYSE:TOT).

seeking alpha