Crude Oil’s Shaky Fundamentals Don’t Lie

Crude oil hasn’t done much all year, largely trading within a $3 range.

That scenario is starting to change…and all signs point to crude prices sliding.

The Organization of the Petroleum Exporting Countries (OPEC) announced it would ‘freeze’ crude supplies at 1.2 million barrels of oil per day (MMBOPD) into June last year on 30 November. So far, that’s been a great outcome…for OPEC.

OPEC normally cuts supply during the Northern Hemisphere winter months (December to February). That’s when demand tends to pull back on a seasonal basis. Crude demand slowly starts to pick up following this period. June to September signify the seasonally high-demand months. That’s when crude demand normally surges…and prices increase.

Indeed, looking at its supply deal, OPEC gets to receive higher crude prices all year round.

The ‘cut’ was a manipulative tactic, aimed at artificially driving up crude prices. OPEC will still produce more crude than it did in 2015 — a year when crude prices were in freefall.

It sounds crazy…especially when you consider the US shale game, which doesn’t get much attention. With higher oil prices, the US rig count has exploded in recent months. In its own right, that’s seen a lot of production added to an already-oversupplied crude market.

It’s a recipe for disaster when it comes to the supply-demand balance. That’s why crude prices have started to move south. While crude prices are unlikely to plummet, I expect significantly lower crude prices in the months ahead.

Crude oil starting to show weakness

CNBC reported on 14 March (my emphasis added):

It was a rough week for the crude oil market.

After months of relative price stability, with WTI oil prices pinned between $50 and $55 per barrel, the floodgates of selling opened wide, as the record amount of long positions that was built up by speculators over the preceding weeks was, quite obviously, liquidated, as evidenced by sky-high volume in both futures and option contracts.

There were several catalysts: Crude oil inventories in the United States hit a new, record level, according the Department of Energy’s weekly status report, which also showed U.S. oil production rebounding to within five percent of last year’s record to nearly 9.1 million barrels per day.

Of course, the steadily rising oil rig count indicates that even more production is on the way, and it is not impossible to foresee overall production rising toward 10 million barrels per day over the course of the next 12 months.

It doesn’t look great for the crude oil bulls. US crude production is at an all-time high.

With plenty to talk about, global energy leaders met in Houston, Texas last week. The meeting included officials from several OPEC countries, as well as Russia.

Statements from Saudi Arabia’s oil minister, Ali bin Ibrahim Al-Naimi, and OPEC’s Secretary General, Mohammed Barkindo, were hardly reassuring.

Al-Naimi said the countries freezing oil production wouldn’t stand for ‘free-riders’. That’s a term he used to describe the shale producers. However, there’s not much OPEC can do. Its manipulation tactics are starting to backfire. Artificially-higher oil prices have helped resurrect the US shale game.

Take a look at the chart below:


Source: Market Realist
[Click to enlarge]

The green line shows the US oil rig count. It has increased 33 times in the past 36 weeks. US crude oil rigs are at the highest level since September 2015. The US crude oil rig count peaked at 1,609 in October 2014. The blue line shows oil prices, which have a strong correlation with the rig count. In other words, as long as oil prices remain high with OPEC manipulating the market, US shale production should increase. Today, crude oil prices have jumped about 80% from their 2016 lows.

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OPEC’s manipulative strategy is backfiring

Saudi Arabia is starting to worry.

It’s got massive socialist-spending promises, a military intervention in Yemen to fund, a war against ISIS, and a currency peg to finance. And, with the country bleeding foreign reserves by the day, it’s looking to list Saudi Aramco — the country’s state-owned oil company — on the New York Stock Exchange.

Saudi Aramco’s value has been estimated at anywhere between US$1.25 trillion and US$10 trillion, making it the world’s most valuable company.

Saudi Arabia has an incentive to keep oil prices high. Saudi Aramco could generate as much as US$2 trillion in revenue for the country next year. That is, of course, if oil prices remain high. If crude prices begin to plummet, investors will pay less for Saudi Aramco.

With plenty up for grabs, Saudi Arabia announced that it would, once again, supply full contract volumes of crude oil to its Asian customers. It’s already started to aggressively discount prices.

Is this the beginning of the end for the OPEC and non-OPEC production accord?

Only time will tell. But it’s hard to see how the ‘fraudulent’ deal can stay together.

This could get ugly for oil producers…

With US refineries undergoing seasonal maintenance right now, US oil inventory levels could skyrocket even higher when the production units return to service in the coming weeks.

Crude oil high locked in for 2017

If you’re wondering where crude prices are set to go next, take a look at the daily chart below:


Source: Tradingview.com; Resource Speculator
[Click to enlarge]

The pink uptrend line defines the market from the early 2016 low. US crude remained relatively strong throughout last year. The pink uptrend line has broken down in recent weeks.

The blue downtrend line shows the main resistance from early 2015. US crude prices tried to jump above it multiple times and failed. It broke out following Trump’s election last year, which also coincided with the OPEC and non-OPEC deal. Following the breakout, crude has consolidated sideways…waiting for more news.

The recent pullback targeted the blue resistance line, which has now become the support level. US crude oil must close below US$49 per barrel on a weekly basis to remain bearish. That happened last week, but consecutive weekly closings would demonstrate that oil isn’t as strong as many expect. If that happens, crude should test the red support level at the US$45 per barrel zone.

Of course, crude’s selloff doesn’t rule out another bounce…

The black horizontal line shows the major resistance level for a bounce. That stands at the US$51.62 level. I’d like to see a re-test of this resistance before moving lower. If that happens, crude oil could move to re-test the November lows near US$42 per barrel.

The bottom line: I believe the high is locked in for crude oil this year. But pay attention to the technical levels in the weeks ahead to stay on the right side of the trade.

Regards,

Jason Stevenson,
Editor, The Daily Reckoning

PS: Although crude and oil stocks don’t look great at the moment, that doesn’t mean all energy sectors are out of favour. I’m eying one sector of the market set to make triple-digit gains. In fact, I’m in the final process of analysing and writing up my latest ‘Gigastock’ tip for Resource Speculator. To find out more, click here.

Jason Stevenson

Jason Stevenson

Jason Stevenson shares his extensive knowledge of Australia’s mining sector as The Daily Reckoning's dedicated resource analyst. Whether it’s iron ore, gold, copper or lithium, you can rely on Jason to give you in-depth analysis of the biggest and most important sector of our economy. Jason provides in-depth research to Resource Speculator, Australia’s premier resource investment advisory.

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