Another Doomed Rally in Oil

The upside for oil is extremely limited.

By Martin Tiller, Oil & Energy Insider:

Most people who study energy markets believe that, at some point, oil will recover, at least partially. Not even the most bullish observers see $110/Barrel oil returning in the foreseeable future but a bounce back to around $50 is a common prediction. Those predictions got a lot of airing this week as oil bounced off of the recent lows in the mid-$20s. But a look at the reasons for that bounce and the fundamental situation suggests that this may be just another false dawn, and at least one more test of the lows will be needed before there can be a meaningful, sustainable recovery in oil.

The main thing that sparked the rise was the revelation at the end of last week by the UAE Oil Minister that some OPEC countries were talking about the supply situation. As it became known that Russia and, more importantly, Saudi Arabia were involved it looked like something of real significance. There has been so much talk of the complete collapse of OPEC that any hint of agreement was seen as a positive for the commodity.

That sentiment was so strong that, even when the limited and somewhat disappointing details of the proposed agreement were released this week the rally continued. The fact that even the Iranians agreed to the proposed production freeze at current levels added fuel to the fire. In reality, though, a freeze at current levels does nothing to alleviate the pressure on oil. We are at record high production levels, and it will take some time for global demand, which is increasing but at a slow rate, to even catch up let alone to make a dent in the significant stockpiles of oil that currently exist.

That didn’t seem to matter, though; a market starved of good news seized on any compromise as a positive and WTI jumped close to twenty percent over a three day period. Market dynamics no doubt played a part in that exaggerated move; once an excuse was found for a move up some sort of short squeeze was inevitable and the sudden run up had the feeling of just that.

Later this week, however, reality intruded when U.S. crude inventory numbers showed an unexpected build, despite increased refinery activity. The simple fact is that the oil industry is currently producing more oil than the world needs, and freezing at these levels, while a start, doesn’t address that basic problem. If that were the only thing affecting the oil price, however, the short squeeze may have been enough to at least allow the price to stabilize above the previous lows, but it isn’t.

The biggest fundamental factor on the price of anything is the relative strength of whatever it is priced in. In the case of oil, that is the U.S. Dollar, and if dollars are perceived as generally more valuable, then anything priced in dollars loses value. What gave real strength to the rally last week was that it coincided with a mini collapse in the dollar index, down from highs around 100 to around 95. That move is now showing signs of reversing, though. And if that continues, the upside for oil is extremely limited.

In short, then, as welcome as this week’s “recovery” in oil prices was to many, it looks doomed to be short lived. Until the fundamental factors affecting the price of oil, over supply and a strong dollar, actually change, any rally is a trading opportunity, but not a real recovery. Given that, another test of the lows looks to be on the cards over the next couple of weeks. Maybe, if that comes, it will be enough to force meaningful production cuts in the U.S. and OPEC countries and/or those lows could coincide with a delayed rate hike by the Fed, in which case the scene would be set for a real bounce. Absent that, though, this looks like just another false rally. By Martin Tiller, Oil & Energy Insider

Political baloney doesn’t fix the fundamental issue in the oil market. Read… The Saudi/Russia Oil Deal “Just a Bunch of Bull.” Here’s Why

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  12 comments for “Another Doomed Rally in Oil

  1. michael says:

    Oil will recover once the recession (depression) is over.

  2. Nick Kelly says:

    And guess what- Iran DID NOT agree to freeze production at current levels- which in English means the level at this moment in time.
    When I first saw that announcement I thought it didn’t make any sense for IRAN to freeze at levels far below the pre-sanctions level.
    Iran agreed to freeze production at the pre-sanctions level, of course
    So whatever the verbiage a lot more Iranian oil is coming on the market.

    • d says:

      Saved me the job.

      Price is being jawboned up at the same time production is still increasing daily.

  3. night-train says:

    At $50/bbl, it will not mean a big recovery for US production. Certainly not enough to create another boom in the foreseeable future. Some production will be more economic at that level, but not most of the shale plays which were the source of the US’s record production levels which were spurred by $100+/bbl oil and large inflows of seemingly unending nearly free money. I expect bankers who have been, or will be, burned by the oil price bust, to place some checks and balances in new loans. By that I mean, bankers will take a closer look at production histories of wells and fields and to require wells be drilled and produced in new prospect areas before making further loans. In short, what we once called due diligence.

    And if I was calling the shots for OPEC (assuming anyone is) or any new cartel, I would target a price in the mid $40s to further damage US shale operators. Another couple of years at that rate would lay waste much of the shale competition.

  4. Jack the Ripper says:

    Crude oil futures for 2017 point to $40 a barrel. If they froze production, (except for Iran ), it would no doubt be higher.
    Oil’s future is not that dismal.

    • Wolf Richter says:

      Iran said yesterday (?) it already boosted production by 500,000 barrels per day since the sanctions were lifted and is shooting for 700,000 in the near future. Iraq is still increasing output too. So even if Russia and SA freeze production (at their near-record levels!), the global glut isn’t likely to disappear anytime soon.

      Everybody knows that oil cannot stay this low forever. But it could stay low for a lot longer. See US natgas.

  5. MC says:

    All the oil rallies we had since 2014, each and every one of them, were not driven by fundamentals (more on which in a minute) but by desperate attempts to reinflate asset prices. Untold billions were thrown at oil futures to send them skyrocketing again and absolutely everything failed: I am really intrigued by the fact while budgetary woes in Russia and Saudi Arabia and debt servicing issues in the US are everywhere these days, nobody spent a word about the massive losses speculators have incurred to try force a rally. This was no pocket change. Who ate these losses?

    Now, regarding fundamentals. I am starting to be quite skeptical of official figures. The US and Japan have stable refining capacity, while in the whole of Europe refining capacity has been on a steady decline. This leaves Asia alone fueling new demand.
    But China has started exporting large quantities of distilates in the past six months. To this it must be added China has taken advantage of the market share war between Russia and Saudi Arabia in the Far East to fill her recently expanded strategic reserves to the brim.
    Exactly how much demand is truly the result of increased economic activity and how much the result of China being China? Those distilates they are selling are not going to fuel any new growth: they are competing with Indonesian, Malaysian and chiefly Japanese distilates for market shares throughout all Asia.
    In short I suspect China is up to its old tricks of doing everything to keep the factory (or in this case refinery) doors open.

    As I previously said, ULSD prices continue to stay depressed because of the connection between decreased (at this point stagnating is not enough to explain this situation) economic activity and refineries working at breakneck speed.
    Europe has long being the dumping ground for ULSD for the simple reason prices tend to be higher than anywhere else. But ARA (Amsterdam-Rotterdam-Antwerp) storage facilities are bursting at the seams after US, Moroccan, Saudi etc refineries dumped their ULSD there with complete abandon. Both Exxon and Marathon have suspended ULSD deliveries to ARA in December already: it makes no economic sense for them anymore.

    While there sure is a serious glut, the problem is made much worse by the fact everybody “still thinks this is 2006”, in the immortal words of a friend of mine. Tumultous economic growth has been taken for granted for a decade or more now, and nobody wants to see things have completely changed since 2009: we may have ourshort vacations from pain, but bills for that phony growth are coming due.

    • NY Geezer says:

      Since you are blaming various parties for the spikes in oil futures prices over the last 2 years, you might also want to consider the various players in the fraking industry .

      It is a marvelous 2 year run of luck that the frackers have had acquiring enough favorable hedges during price spikes at sufficiently high oil selling prices to keep them afloat as the average price of oil falls. Its as if these frakers have inside information as to when to acquire the hedges. If they acquire the hedges too soon or too late they will not get good enough hedges to pay for their drilling costs and to make the payments on their bonds for the next 12 months.

      On the other hand, that run of luck might not be luck. It might be the fruits of the manipulation of the oil futures market via the coordinated buying of several frakers and their creditors who were interested in the frakers obtaining exquisitely good hedges. Any money these parties might have lost buying futures to drive the oil price higher would be just a small cost for their businesses in exchange for obtaining high yielding hedges to keep the frakers afloat and their bonds out of default for another year. If some speculators got caught in the buying frienzy that is expected and helps spike the oil price higher on the speculators’ dime.

  6. Ptb says:

    World consumption rose 2% while production was up about 6%. So in the frenzied trading world this is called a “glut”. Basically a 4% delta or 4M per day. What would it take to make this gap swing either way??

    • Mad Max says:

      I tend to subscribe to the Taps Coogan philosophy that the price has a whole lot more to do with the strength of the dollar than supply and demand

      The Fed is tightening and every other CB is still full blown dovish.

      The dollar has strengthened against every other currency: the Pound, the Euro, the Franc, every kinda yuan you can think of. What am I missing?

      What would it take to swing prices? I would say it would take the world realizing that there is 0% chance that the Fed keeps tightening beyond 1, maybe 2 more hikes.

  7. Everyone and their grandkids talk about ‘production’ — extracting more oil out of the ground (or less). Talk, talk, talk … what a distraction.

    Nobody talks about consumption, this is assumed to always take care of itself. Customers will always have money to pay ‘whatever’ price. However, except for farmers and a handful of others, nobody uses fuel to pay for the fuel. Driving stupid cars in aimless circles is non-remunerative. Just about everyone who drives, borrows.

    What’s underway right now is credit unraveling. It’s underway everywhere on planet Earth.

    The price of fuel is the ‘loan’ price of fuel the same as the price of a house is the ‘loan’ price of the house. It does not represent cost of the material + land. (Land is free, it doesn’t cost anything to make). If you were to strip mortgages from house prices the result would be a price crash. Strip the loans from fuel price and the outcome is exactly the same = crash (underway since 2014).

    The customers are broke, they cannot borrow for dumb stuff any more. Tomorrow, more customers will be broke, especially if their is additional QE, NIRP, moral hazard, a war on cash, etc. All of these things send a greater proportion of credit toward tycoons … and away from customers. As wasteful as tycoons may be they cannot by themselves support a mass industry that relies on sales to ordinary people in their billions.

    No matter what the suppliers do — wars, embargoes, manipulations, bailouts — their customers will still be broke. From now as far as the eye can see. Broke.

    What will happen next is absolute (as opposed to relative) shortages as drillers and their lenders go out of business. When shortages hit another tranche of customers will fall by the wayside. Too little fuel will does not make any customer richer. Afterwards comes hard rationing.

    Look for the rationing, it may arrive sooner than you think!

  8. Shawn says:

    Why the miss information from Reuters. This is ridiculous.

    Oil soars 7 percent on bets of US shale output falling, equity rally

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