OPEC Is Dead… For Now
Talk about whiplash on Wall Street!
Last week, oil pushed into a bull market. By that I mean it rallied more than 20% from the lows it hit earlier in August.
A 20% rally is the technical benchmark for a new bull market. But just three weeks earlier, crude oil dropped into a bear market.
Then, this week, oil tumbled again.
If energy investors aren’t confused, they aren’t paying attention.
Don’t worry. I’ll give you the scoop today. I’ll also give you a trading idea.
Still Stuck in the “Goldilocks Range”
First, let me point out that in the January issue of Oxford Resource Explorer, I predicted that 2016 would see “the death of OPEC.”
Considering the once-feared cartel has devolved into squabble, OPEC sure looks dead… for now. It has lost its political punch. It may come back to life down the road, reanimated like some oil-fueled Frankenstein’s Monster. But for now, it’s comatose at best.
Second, at the Investment U Conference in April, I forecast that oil would remain in a “Goldilocks range” between $35 and $50 into the fourth quarter. Let’s see how that prediction is working out…
Despite a very brief push above that range in June, I’ve seen nothing to change my forecast. This Goldilocks range is invalidated only if prices push above the “trigger point” I have marked on the chart.
We know what pushed oil down into bear market territory: a global supply-demand imbalance.
This has mainly been driven by new supply from OPEC, led by Saudi Arabia. OPEC production rose to 33.106 million barrels per day in July. That’s up 46,400 barrels from June. It’s a million barrels more than the cartel’s average production in 2015 and 2 million more than in 2014. Saudi Arabia led the way, with production at a record 10.5 million bpd in July.
According to thSo that’s 300,000 bpd that had to go into storage… storage that was already bursting at the seams.
So why did prices rally so hard in August?
Well, the market is often an expectations game.
Looking at the Short Term
See, many oil traders shorted oil for months, expecting oil prices to stay under pressure. The market was one big bear’s den.
Then, two weeks ago, Saudi Arabia’s energy minister, Khalid al-Falih, gave oil bulls hope. Falih said the kingdom was willing to “discuss any possible action” needed to stabilize prices at OPEC’s informal meeting in Algeria next month.
That set off a mad scramble to cover short positions. Then new bulls charged after the bears. The short covering became a rout. Prices surged.
But that’s all market speculation. Financial histrionics. Is there any change to actual oil fundamentals?
To be sure, U.S. oil production has gone down. Including both crude and liquids, production should average 13.6 million bpd this year. That’s a drop of almost 3% compared to last year’s production.
But drillers are already getting back to work in the U.S. oil patch. Devon Energy Corp. (NYSE: DVN), Pioneer Natural Resources (NYSE: PXD) and Newfield Exploration (NYSE: NFX) are just three of the companies that say they can make money with oil at recent prices.
More than 70 oil rigs have gone back to work across the U.S. this summer. According to Baker Hughes, which tracks rig activity, the oil rig count was recently at 406 – up 28% in the past three
And there are other recent developments that could bring more production online globally.
Total Iraqi oil production could rise by 150,000 bpd, as the country made a deal to export oil from fields in the Kurdish-controlled Kirkuk region.
Civil war in Nigeria is calming down. That raises the odds of more production from that OPEC member.
And Iran is saying loudly that it plans to increase its production and exports.
So I’d expect that oil will continue to top out at $50 for at least this quarter. Perhaps part of the fourth quarter as well.
But that’s short term. Longer term, things are looking bullish.
Project Spending Slump
According to researchers at Wood Mackenzie, spending for the development of new oil projects between 2015 and 2020 has been slashed 22%, or $740 billion. Another
This could mean a drop in production of 7 billion barrels of oil equivalent from 2016 to 2020.
Sure, maybe more oil production will come back online. But how many oil companies will be eager to restart expensive offshore projects if they aren’t sure oil will remain above $100 per barrel?
So that could weigh on new supply for a long time to come.
Meanwhile, U.S. oil exports are ramping up…
U.S. crude oil exports averaged 501,000 bpd in the first five months of 2016. That’s up 9% year over year.
That’s a trend that should only continue. And more overseas demand for U.S. crude should support prices.
So longer term, I’m actually quite bullish on oil prices. I think we could see prices start to make some real progress late this year or early next year.
One way to play this is to buy an industry that was steamrollered by lower oil prices… but now is bouncing back.
I’m talking about oil explorers and producers.
Those are tracked through the SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP). It holds a number of companies, including Chesapeake Energy (NYSE: CHK), Rice Energy (NYSE: RICE) and Devon Energy, which I mentioned earlier.
Looking at the chart, you can see that the ETF still has to break out. And it could zig and zag before it finally breaks out to the upside. But once it does, I think it could run to $65 pretty quickly.