Agreed to Consider

Jim Brown
 
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Oil prices rallied strongly all the way back to resistance at $48.50 on the OPEC headlines out of Algeria. Unfortunately, it is just a headline.

OPEC agreed to "consider" cutting production at some point in the future if countries eventually agree at that point. The sideline meeting of OPEC ministers in Algeria this week was somewhat productive. At least they did not break up in disgust with everyone pointing fingers at everyone else. as we saw at the prior meeting.

The attendees agreed to consider a group production target of 32.5 to 33.0 million bpd. In August, OPEC members produced 33.24 million bpd. The headline was scripted for market consumption saying a cut to those levels would "accelreate the ongoing drawdown of the stock overhang and bring rebalancing forward."

The OPEC ministers said a committee of representatives from member countries would calculate recommended production levels for OPEC countries and consult with non-OPEC countries, insert Russia here, and suggest production levels that would help stabilize inventories.

The ministers would help each country "identify risks and proactive measures that would ensure a balanced oil market on a sustained basis." Those recommendations would be considered at the November 30th OPEC meeting in Vienna.

The "proposed" agreement they will discuss at the end of November allows Iran, Iraq, Libya and Nigeria to continue increasing production. Iran will theoretically stop additional production once they get to 4.0 million bpd. Currently they are producing somewhere in the 3.6 to 3.8 mbpd range.

General David Petraeus, now a partner at private equity firm KKR, called the agreement to consider a production cut "nonsense." He is somewhat of an expert on the Middle East. He believes Saudi Arabia will continue to raise production whenever they can because Saudi Arabian foreign currency reserves have declined -20% to $587 billion. Saudi announced last week they were cutting pay for government officials by 20% and reduce perks for public sector employees, which make up 66% of the country's workforce. Saudi Arabia is suffering and they need every dollar they can get from oil production.

We know that Iran will never cap production. They may claim they have capped it but they will keep increasing production whenever possible. Libya said production had doubled in recent weeks to 485,000 bpd but they were producing 1.6 mbpd before the civil war. That is their eventual target but it could take a couple years to return to that level. Nigerian production was down over 1.0 mbpd at one point and they are slowly recovering that lost production but it will take additional months to repair all the rebel damage.

The OPEC officials claim they are going to negotiate with Russia about cutting production. That is a waste of breath and the Russian oil minister has already said there will be no production cut or cap. Russia is drowning in a sea of red ink and they also need every dollar they can generate.

The headlines succeeded in lifting prices in the weakest two months of the year. The entire exercise was planned to produce headlines that would cause a short squeeze in crude prices. This is September 29th. If they really wanted to cap production they could have done so at the Algeria meeting. They do not need to wait until November 30th to meet again and consider a production ceiling that in reality will not be a ceiling. If four members plus Russia can continue to add to production then there is no cap at 32.5 mbpd even if the November meeting actually produced an agreement.

In November the OPEC officials are supposed to tell each country how much they can produce. Good luck with that. Every country is bleeding cash and being told you have to cut your income by 10% is not going to go over well. Historically OPEC has a very bad record for sticking to quotas. The last time they had a quota they were actually producing up to 2.0 mbpd more than the quota.

Here is the kicker. Saudi Arabia produces an extra 1.0 mbpd in the summer time and they burn the oil to make electricity for cooling. After summer is over, they reduce production by that same 1.0 mbpd. This year they can say they are cutting production by 1.0 mbpd and generate an extra week of headlines that help lift prices even though they have been making this production every year for as long as I can remember. Watch for that headline.

Temporarily crude prices are higher. They rebounded to resistance at $48.50 as the shorts covered their positions. Now with all the analysts warning the "agreement to consider a cut" may never produce an actual cut, the gains are losing traction. Even if a deal were struck, it probably would not begin until January. That means the glut will continue to grow for the next three months as Iraq, Iran, Libya and Nigeria continue to increase production.


Venezuela's oil minister warned last week that oil production was 10% too high at the current 94 million bpd. He said production must be cut by 10% or 9.4 million bpd in order to reduce inventories and generate a fair price of around $70. I think Eulogio Del Pino needs to lay off the recreational drugs because his perception of reality is significantly skewed. Most analysts believe the current over supply is only 800,000 to 1.2 mbpd. Global inventories are at record levels and we do need to see production decline to the point where those inventories begin to deplete but OPEC countries are not going to cut production 10%. That is an impossible number. If global production declined only 2.0 mbpd to 92 mbpd it would take a very long time for inventory levels to normalize and prices rise.

I will revisit the production cut scenario as we get closer to the November 30th meeting. OPEC ministers are known for not being able to keep secrets and any fractures in the ranks will be public knowledge well before the OPEC meeting.


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  Active Rigs

Active drilling rigs rose +5 to 511 for the week ended on Friday 9/23. Oil rigs rose +2 for the week to 418. Active gas rigs rose +3 to 92. Active rigs have now declined -1,420 since the high of 1,931 in September 2014. Active offshore rigs were unchanged at 20 after peaking at 61 in 2014.


Oil Inventories Week Ended 9/23/16

Crude inventories fell -1.9 million barrels to 502.7 million. This was the fourth consecutive week of declines in a period that normally sees inventory gains. The historic high at 543.4 million was on April 29th.

Refinery utilization fell from 92.0% to 90.1% as refiners begin the fall maintenance cycle.

U.S. production fell -10,000 bpd to 8.50 mbpd. That is a decline of 1,113,000 bpd from the peak in 2015 of 9.61 mbpd.

Cushing inventories fell -600,000 barrels to 62.1 million and a 3-month low.

Gasoline inventories rose +2.0 million barrels to 227.2 million but gasoline demand fell to a 3-month low at 8.88 mbpd.

Distillate inventories fell -1.9 million barrels to 163.1 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 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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