Crude Jumps 11% in Two Weeks… But the Rally Is Just Getting Started

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

The price of crude oil has risen 11% since the first week of May. You may be wondering… what’s next?

We’ll know for sure tomorrow… but we may already have the answer.

When OPEC originally announced production cuts in late November 2016, the idea was that those cuts would be in place for six months.

OPEC, Russia and several oil-producing countries agreed to reduce output in the first half of 2017 by 1.8 million barrels per day (bpd). And the majority of OPEC members have been compliant with that deal.

But ahead of tomorrow’s big OPEC meeting, the plan being floated by Saudi Arabia and Russia is to extend the cuts an additional nine months to March 2018.

Saudi Arabia has led the charge – and for good reason…

It is by far the largest OPEC producer…

And it has the most at stake.

It makes for a very bullish scenario for crude investors.

OPEC’s Free-Falling Oil Revenue

In 2016, OPEC earned $433 billion in net oil export revenue. That was a 15% decline from the $509 billion the cartel earned in 2015.

Obviously, the massive drop in crude weighed heavily on OPEC’s revenue last year.

But the news was even worse than that…

Revenue for 2016 was the lowest OPEC had seen since 2004.

And it was a dramatic downturn from the more than $1 trillion in revenue OPEC earned each year from 2011 to 2013… or the $933.5 billion in net oil export revenue the cartel saw in 2014, when crude peaked… and then started to collapse.

In fact, OPEC’s oil export revenue in 2016 was down 58.6% from its peak in 2013. That’s a brutal drop. And it’s why OPEC countries like Saudi Arabia are trying to expand their economies to become multidimensional.

As I’ve touched on before, that’s part of the point behind the Saudi Aramco IPO: to help fund these initiatives.

Of course, not all OPEC members were created equal. Saudi Arabia is by far the top dog.

Of the $433 billion in oil export revenue that OPEC reported last year, Saudi Arabia accounted for $133 billion, or 30.7%.

But 2016 was a difficult year for the kingdom. The last time Saudi Arabia saw lower oil export revenue was when it hit $109.9 billion in 2004.

Yet, because of the importance of the Saudi Aramco IPO, Saudi Arabia has shouldered the load in terms of production cuts.

But don’t think it’s the end of the world for OPEC.

This year, the cartel expects to see net oil export revenue increase 24.5% to $539 billion… and that’s with production cuts already in place. Plus, revenue is projected to increase another 10.4% in 2018 to $595 billion.

Already this year, from January to April, OPEC’s net oil export revenue has been $179 billion. Of that, Saudi Arabia has accounted for $54 billion, or 30.2%.

Flies in the Ointment?

There’s a lot of talk about Libya and Nigeria unraveling the impact of the production cuts. I find it odd for a few reasons…

First, the two countries are both exempt from the deal.

Libya is trying to get back on its feet after two civil wars. And Nigeria’s pipeline infrastructure was decimated by attacks from the Niger Delta Avengers, cutting the country’s crude output in half.

Since 2012, Libya’s net oil export revenue has dropped 95.4%. Nigeria’s has declined 72.4%.

Now, let’s be honest… Crude has jumped twice because of Libya’s largest oil field being shut in. In Nigeria, the pipelines are being rebuilt only because the Niger Delta Avengers have recently gone quiet…

But that doesn’t mean they’re gone.

These are still two volatile situations… but if anything, they’ve led to a rise – not a drop – in crude’s price.

Not According to Plan…

In terms of cuts, the biggest issue is with Russia. It’s supposed to reduce output by 300,000 bpd. But in March, it had cut just 177,000 bpd.

Meanwhile, Saudi Arabia and 10 other oil-producing countries that agreed to cuts are exceeding their targets.

Of course, the biggest thorn in OPEC’s side is the U.S. Production from the U.S. is already outpacing estimates for the year. OPEC is forecasting that U.S. crude output will increase another 600,000 bpd this year.

But here’s the deal…

In April, OPEC crude output fell to 31.73 million bpd.

Production fell in the United Arab Emirates, Libya, Iraq and Iran… but it rose in Angola and Saudi Arabia. Then again, those increases aren’t surprising, as both countries still exceeded their production cut targets. And Saudi Arabia’s increase was a mere 50,000 bpd.

… But Still Effective

Now, the International Energy Agency (IEA) reported that OPEC’s plan is not only working…

It already worked.

In the first quarter, the global oil market was almost balanced. Global oil stocks grew 100,000 bpd. In the near term, this is accelerating. In March, these crude inventories fell by 1 million bpd.

The IEA sees a likely drawdown of 700,000 bpd for the second quarter.

And that’s because, as I’ve written about here previously, we’re exiting refinery maintenance season. Refiners are the biggest consumers of crude. And by July, the global crude throughputs should increase to 2.7 million bpd. This steady demand growth will lead to global stocks continuing to be drained.

And we’re seeing this in the U.S… The EIA reported that U.S. crude inventories fell for the sixth straight week in a row. Gasoline stockpiles are on the decline too – right in time for summer driving season.

The supply and demand picture for crude is a bullish one. For the next several months, prices should be buoyed by OPEC production cuts and surging refiner demand… not to mention any political risk, especially from countries like Libya and Nigeria.

Don’t get distracted from the bigger picture. And continue to take advantage of any dips.

Good investing,

Matthew