Crude oil is in a downtrend. There will be many excuses for it, but the main reason is that there are too many weak handed longs in oil currently. The major trend in oil is up, but it is dire need of a reset – meaning a retest of the 2/11/16 secular lows at $26. We’ve been concerned about oil for awhile, such as this post from 1/21/17:
“….my outlook remains that we will see a secondary test of the $26 secular low, but at a much higher low. Crude oil is in a major accumulation area, but this bottoming process will take quite awhile. Energy prices in general are very bullish long term, it’s just that crude itself has alot of competition now and alot of technology – tho increasing high-yield interest rates will be helpful to knock out some of the weaker fracking companies. Oil production is very capital intensive – the fracker’s supply growth needs both high enough prices and low interest rates. It’s not just prices. And this whole green energy hysteria/government edict/carbon taxes (Trump notwithstanding) is a tough barrier for basically the internal combustion engine and the use of crude oil. But this is looking way down the road, and in the meantime there are potentially bullish geopolitical factors. A selloff in oil and a re-test would be very helpful to strengthen the market. There is a very large speculative long position in crude oil futures currently, and a break of support, like $49.50, will start to trigger sell stops.”
Crude hit more new lows today, and a bounce is in order, but be careful. And these problems with oil will have effects on several other markets, like junk bonds and the stock market. The following article is good, but just keep in mind that the main problem for oil is the weak hands having to deal with sell stop runs.
Last November, OPEC orchestrated an impressive feat: corralling all (or nearly all) of its members to sign on to relatively aggressive production cut deal, and then actually convincing everyone to follow through on those reductions beginning in January. OPEC’s estimated 94 percent compliance rate defied the cartel’s own history of cheating and mistrust, and OPEC has taken around 1 million barrels of oil production per day off the market.
They were initially rewarded for this. Oil prices rallied more than 20 percent in the month after the deal was announced and investors and analysts have been mostly bullish on crude prices ever since. But the cuts were not all that they seemed to be for two reasons: OPEC cut from record highs and countries exempted from the deal ramped up oil production in the fourth quarter of 2016, offsetting much of the reductions.
Member countries (excluding Indonesia, which is no longer a member) produced about 32.5 million barrels per day (mb/d) in August. That was the last month before the September Algiers accord, which was basically an agreement to agree to cuts at a later date. By January, after nearly 90 percent of the 1.2 mb/d of cuts were implemented – or reductions of about 1.1 mb/d – the group still produced a relatively high 32.14 mb/d.
Why the disconnect? Pretty simple: OPEC used an October baseline, when production was more than 400,000 bpd higher than two months earlier. Cutting from a peak made the reductions seem much more dramatic.
Moreover, the countries exempted from the deal offset the steep cuts from countries like Saudi Arabia. Libya has added about 400,000 bpd in output since last summer, while Nigeria has added between 200,000 and 300,000 bpd.
So, we have OPEC talking up a major production cut deal, and also trumpeting its unprecedented rate of compliance. Oil investors listened, and became incredibly bullish on oil prices, expecting a sharp tightening in the market to be forthcoming. But while the participating countries have indeed taken about 1.1 mb/d off the market, they did so from their peak levels, and those cuts were offset by rising output from Libya and Nigeria.
To be sure, Libya’s output is once again under threat of violence near the country’s largest export terminals – Libya has already lost about 80,000 bpd in recent weeks. And recognizing Nigeria’s threat to the integrity of the OPEC deal, OPEC officials have suggested that Nigeria could lose its exemption status if the cartel extends the deal for another six months.
Nevertheless, about midway through OPEC’s six-month deal, the headlines about success are belied by a much more measured impact on supply fundamentals. The bottom line is that OPEC has only taken a few hundred thousand barrels per day off the market from last summer’s levels. And those barrels from the Middle East are quickly being replaced by barrels from Texas. U.S. oil production is closing in on 9.1 mb/d, up about 600,000 bpd from last summer. After largely ignoring this growing threat, hedge funds and other money managers have suddenly grown more concerned as bloated inventories continue to rise, and a liquidation of net-long bets could be underway. Bullish bets are now at a one-month low and could be heading down. That helped spark a sharp correction in oil prices last week, down about 9 percent in a few days.
In short, the OPEC deal was kind of weak to begin with, and now U.S. shale could be killing off the OPEC-fueled oil price rally.
What happens next is uncertain. The much faster return of U.S. shale production and soft oil prices have sparked a growing chorus within OPEC to extend the six-month deal until the end of the year. This week Kuwait became the first member to officially endorse a roll-over of the production cuts for another six months. “Kuwait supports the extension of the agreement after June,” oil minister Issam Almarzooq said, a move that will ‘‘accelerate the rebalancing of the global oil market and will contribute to the return of prices to levels acceptable for producing countries and for the petroleum industry in general.”
Iraq and Angola have also suggested they would be open to an extension. The all-important Saudi energy minister has not endorsed such a move yet, but has shown more willingness to consider the move recently.Related: What’s In Store For U.S. Shale Oil?
But the rebound in shale can cut both ways on OPEC’s calculations. For OPEC to sacrifice more of their production only to see shale producers quickly fill the void hardly inspires confidence. Ceding market share while only marginally boosting prices is not what OPEC had in mind when it agreed to cut output. The longer the cuts drag on without further price gains, the more likely members will grow tired of the arrangement. That increases the likelihood of cheating.
So while the shale rebound is pushing some within OPEC to consider an extension, Russia’s top oil company said the opposite dynamic might play out: a swift return of U.S. shale could lead to an unraveling of the OPEC deal altogether. “There are significant risks the (OPEC-led) deal won’t be extended partially because of the main participants, but also because of the output dynamics in the United States,” Russia’s state-owned company Rosneft told Reuters. “We think that in the long-term global oil demand dynamics and reduced investment during the period of ultra low prices will balance the market, but that the risk of a price war resuming remains.”
In other words, the comeback of U.S. shale could not only kill off an extension of the OPEC cuts, but it could force all parties to once again engage in an all-out fight for market share, leading to another downturn in prices.
Leave a Reply