Rope a Dope

Jim Brown
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The six nation talks with Iran over a long term agreement on the nuclear issue ended without any progress. Surely nobody was surprised.

The six nations met with Iranian negotiators for five days in Vienna and "there was no tangible progress in this round." This is the way Iran negotiates. They wear the other side down by countless delays and insistence on talking about things that do not relate to the subject at hand. They have been doing this for ten years and they have gotten very good at it. I call it the Iranian Rope a Dope after the strategy Mohamed Ali used in the ring for years. He covered up in a defensive posture and let his opponent wear himself out with ineffective punches. After the opponent tired Ali would then go on the offensive to win the match. Iran is trying to wear down the other side until the six nations finally tire of the lack of progress and give in to meaningless concessions.

The two sides will meet twice more in June but the spokesman for the six nations were not optimistic about the outcome. At the meeting that just ended the parties were supposed to begin drafting the final agreement that would be signed before the July deadline. Iran's Deputy Foreign Minister said "No drafting will be done until both sides have reached an agreement." Since the wording of the final agreement is always a thorny issue this provides one more chance for Iran to stall. They can drag their feet right up to the July deadline and then agree to agree but then object to every sentence in the drafting process and drag things out for additional months. They have done this before, multiple times.

The agreement must be signed by July 20th to rescind banking and trade sanctions in exchange for permanent limitations on Iran's nuclear program. The Supreme Leader said a couple weeks ago he does not believe an agreement will be reached and Iran will never give up their nuclear rights. Negotiators want to restrict the number of centrifuges Iran can have. The fewer the centrifuges the slower the enrichment process. Iran is said to have between 10,000 and 50,000 operating units. At the Natanz facility alone they have the capacity for 50,000 centrifuges. Nobody knows how many secret enrichment facilities Iran currently has. Cutting them back to 5,000 centrifuges would be nearly impossible. Even if you could get them to agree on paper how would you ever verify it in the coming years?

I expect the negotiations to go down to the wire and probably miss the deadline. Iran will eventually agree to something and it will be less than the western nations want but they will give up and accept anything just to end the process. A couple years from Now when Iran tests a bomb it will be the next president's problem.

Baker Hughes said active drilling rigs rose +6 last week to total 1,861. This was a 20 month high. There were 326 drilling for gas and 1,531 drilling for oil with 4 listed as miscellaneous. Oil rigs in the Eagle Ford rose +4 to 191. That is the hottest shale play in the nation today. Oil production rose +78,000 bpd to 8.43 mbpd and the highest level since 1986.

The EIA revised its U.S. production estimates higher saying cumulative production from the Bakken, Niobrara, Permian and Eagle Ford is expected to rise +74,000 bpd in June. Texas officials said the average production from the Permian region was revised up by +132 bpd. The EIA expects the Permian region to reach 1.535 mbpd in June as the rig count reaches record highs.

Oil Inventories

Crude oil inventories rose +900,000 barrels to 398.5 million and close to a new record high. Inventories at Cushing declined -600,000 to 23.4 million barrels. Analysts are hotly debating what the minimum operating level is for the storage depot and 20 million is the assumed minimum. If inventories decline below that level the downstream flows to Gulf refineries will be restricted.

Crude oil imports rose slightly from 6.89 mbpd to 7.13 mbpd but that is still well below the normal over 8.0 mbpd. The rising production in the U.S. and the availability of oil by rail is tempering purchases of imported crude.

Distillate inventories declined -1.1 million barrels and remain near five year lows. Inventories are -5.8% below year ago levels. Refiners are exporting distillates rather than push them into the U.S. distribution system. Demand for distillates has been anemic since the recession.

Gasoline inventories declined -800,000 barrels and are now -2.4% below year ago levels. Gasoline demand rose to the high for the year at 9.19 mbpd as winter weather faded and spring temperatures brought drivers out of their homes. Refiners produced 19.45 mbpd of refined products and that was a multi-month high. Refinery utilization declined from 90.2% to 88.8% despite the increased production. The timing of the various numbers received by the EIA tends to fluctuate week to week and causes logical imbalances but they average out over time.

In the graphic below green represents a recent high and yellow a recent low.

The bullishness from the EIA on rapid increases in oil production needs to be taken lightly. While they are expecting production to rise sharply in 2014 their long term outlook is still weak. In the recent Annual Energy Outlook for 2014 they projected U.S. crude production would peak by 2019 at 9.6 mbpd. Since we are at 8.43 mbpd today that suggests only a 1.2 mbpd gain over the next five years or about 240,000 bpd per year. That is outstanding organic growth but far from providing energy independence. We still import more than 7.0 mbpd from other countries.

They hedge their bets by supplying three estimates. The "high oil resource" and "low oil resource" in addition to their actual prediction. In their chart below the center line is the actual estimate for future production. Obviously technology has provided a miracle boost in the last five years so analysts always put in the technology fudge factor for future growth. Tight oil (shale) only provided 8% of our production total in 2008 and it has risen to 35% today. The EIA expects that to rise to 50% by 2019.

In their import chart the outlook is clear. The center line begins to level out in 2017 and rise again about 2019 as shale oil output begins to fade. They caution in the report that "strategic choices made by leading oil-exporting countries could result in quantity and price changes that would impact this forecast." That means another embargo or export halt could raise prices dramatically and lower imports or that an oil price war within OPEC could dramatically decrease prices and increase imports. Both scenarios have happened before.

The IEA updated their global forecast and they claim the demand for OPEC crude will rise to 30.7 mbpd or 800,000 bpd more than they produced in April. This is a +140,000 bpd increase in the IEA forecast in just the last month. They claim stronger than expected global demand has kept stockpiles tight. OPEC controls about 40% of global supplies.

In theory OPEC has the available supply. Unfortunately theory has been trumped by "above ground" problems in OPEC nations. Libya is a prime example with more than 1.0 mbpd of production offline because of internal civil problems. Nigeria is facing an uprising of multiple rebel factions that have reduced export capability. The Sudan is still experiencing problems after their civil war. Iraq is experiencing daily problems with security and infrastructure problems but they are still boosting production a little at a time. They boosted production +140,000 bpd in April to total 3.34 mbpd but pipeline sabotage in the north is going to continue to be a problem. Venezuela is slowing output because of money shortages. No investment means shrinking production. Iran is producing more but they could be put back into the penalty box in August. Saudi Arabia is producing more but in the summer they consume about 1.0 mbpd more oil than normal because they burn it to provide electricity. Saudi Arabia recently expressed concern that internal demand could impact export capability in coming years where oil for export "may decline to unacceptably low levels." Wow! That is a smoking gun admission you would not have heard a couple years ago.

Ukraine is not an OPEC nation but a war there could disrupt the flow of oil by pipeline from Russia.

There is plenty of oil available but it may not be available for export. If the IEA forecast comes true and demand rises 800,000 bpd over April we could see tighter inventories and another rise in prices.

OPEC meets again on June 11th in Vienna to discuss production quotas. They are currently set at 30.0 mbpd but nobody is really enforcing it. They are doing good just to keep that 30.0 mbpd flowing.

Global demand is expected to rise +1.3 mbpd to 92.8 mbpd in 2014. There are quite a few oil analysts that never expected production to rise over 90.0 mbpd so we are in breakout mode here.

With the global economy still limping from the Great Recession and China's economy slowing the real demand boost is yet to occur. If the global economy ever rebounds to 3.5% growth in the developed economies we are going to see a monster demand boom and prices are going to rise significantly. I doubt that is going to happen in 2014 but maybe by late 2015 and early 2016.


It seems like every week is now a pivotal week in the market. The volatility from last week left the indexes close to the flat line but the Russell is still the weakest link. If the Russell 2000 breaks and closes below 1,096 it could damage sentiment on the big caps.

We have been undergoing a rotation from small caps to big caps as a flight to safety. If that implied safety were to erode we could see a reversal and downside acceleration to catch up with the small caps. That is a capital IF.

There are so many factors impacting the market today that it is impossible to pick a direction. I would continue to recommend limiting long positions unless the S&P breaks over 1,900 on high volume or dips to 1,840 for a dip buy.

Hedge fund managers that get paid millions to pick stocks are being crushed by the uncertainty in the market. Don't feel bad if a few of your stocks are down. Raise cash and wait for a buying opportunity. Don't feel like you have to be in the market every day.

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Jim Brown

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