Russia Holds the Key to Prices

Jim Brown
 
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You probably witnessed the short squeeze in crude oil twice in the last three days. With fundamentals becoming increasingly bearish nearly every commodities trader was bearish.

The squeeze on Tuesday came after the Iraqi oil minister suggested there was a deal brewing between Russia and Saudi Arabia. The actual report quoted the oil minister from Iraq saying Saudi Arabia and Russia are "showing signs of flexibility" on reducing the current oil glut. "We have seen more flexibility from the brothers in Saudi and a change in tone from Russia."

Russia has never previously agreed to cutting production or even discussing a production cut. Saudi has routinely said they would not cut production alone, which would cede market share to rivals, including Russia. The challenge would be how to verify production cuts from Russia. You cannot just take Putin's word for it.

Just the thought of a possible change in tone from Russia triggered another short squeeze that lifted oil from under $30 to the high of $32.41. Late in the day additional news headlines suggested the comment was overblown and not to expect an agreement in the near future and prices declined. The next OPEC production meeting is in June.

After the bell the API inventory report showed a monster gain of +11.4 million barrels for last week. The EIA report on Wednesday morning is also expected to show a giant increase.

Goldman's Jeffery Currie, global head of commodities research, warned that crude storage is near capacity restraints. Cushing Oklahoma, the delivery point for WTI, is at record levels and only has about 3 million barrels of capacity. They actually need that for operational reasons as they blend different grades of oil to ship to the coast. The lack of storage means speculators cannot buy oil and store it in hopes of higher prices in the months ahead. If there is nowhere to store it, nobody is going to buy on speculation.

If oil continues lower as expected the U.S. stock market is going to follow. The current correlation between the price of oil and the S&P-500 is 96%. It cannot get much more correlated than that. Since 2009 the price of oil has had an ever increasing impact on equities. When crude began to decline in July 2014 that impact has increased dramatically.

In the chart below the red line is the price of crude and the black line is the S&P-500. Note that for every decline in oil prices the S&P eventually followed. Every uptick produced a cooresponding uptick in the S&P.


With oil inventories rising rapidly the price of crude must go down unless there is a sudden OPEC agreement with Russia. Since Russia is an enemy of Saudi Arabia that chance is slim but it is still a chance. Both are bleeding cash by the billions and that is a strong reason to make a deal.

Crude inventories typically rise through March as refineries are taken offline for maintenance. In April they begin to come back online and immediately begin to refine summer blend fuels to build up the stockpiles ahead of driving season.

This means we should see inventories reach record levels in the next few weeks. Record inventories should mean low prices and that should be negative for the equity markets.

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  Active Rigs

Active drilling rigs declined -13 to 637 for the week ended on Friday 1/22 and that is a 10 year low. Oil rigs fell -5 for the week to 510. Active gas rigs declined -8 to 127. Active rigs have now declined -1,294 since the high of 1,931 in September 2014. Active offshore rigs rose +3 to 29.


Oil Inventories Week Ended 1/15/16

Crude inventories rose +4.0 million barrels to 486.5 million.

Refinery utilization declined slightly from 91.2% to 90.6%.

U.S. production rose +8,000 from 9.227 to 9.235 mbpd. That is a four-month high.

Cushing inventories rose from 64.0 million to 64.2 million and a record high. Cushing only has 3.0 million barrels of available capacity at that level.

Gasoline inventories rose +4.6 million barrels to 245.0.

Distillate inventories fell -1.0 million barrels to 164.5 million.

Details in the graphic are for the prior week. All numbers are not available until the Friday of the following week.

In the graphic below green represents a recent high and yellow a recent low. The blue-green represents a record high.


The weekly OilSlick Newsletter is a publication of OptionInvestor.com. Please visit OilSlick.com to sign up for the free email newsletter that comes out weekly.

This is a publication of the Option Investor Newsletter. Learn how to profit with options on stocks and indexes. If you would like daily market commentary and option recommendations you can sign up for a free trial and have the daily plays and commentary delivered to your inbox. No credit card or phone number necessary.

Free Trial Now

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