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A Bull’s Guide To Oil Markets

Hedge funds know something you don’t: There are still reasons to be bullish about oil. 

Right now, there’s nothing moving the oil price needle in any real way outside of the U.S-China trade war. Everything hinges on the two powerhouses striking a deal, including global economic growth, and hence, oil demand. 

But, while it may seem impossible to try to find a bullish tint in the oil markets, it’s not.  

And while the markets appear to have turned decidedly bearish with supply/demand imbalances drowning out everything else to the extent that even an epic event such as the Saudi Aramco drone attacks that led to the biggest supply disruption in history only provide temporary support for prices, hedge funds see the light at the end of the tunnel. 

So it is time to put our rose-tinted glasses on and imagine several scenarios that could inject some optimism into oil markets on put prices on a bullish trajectory once again.

Once a trade deal is reached, then geopolitical risk will again be able to move the needle, and the rig count will have a decidedly more significant impact on prices. 

So, if you really want to follow the bulls, keep an eye on the hedge funds, which appear to think that oil has room to rally, largely thanks to positive movement on a US-China trade deal. 

During the first week of November, hedge fund bets on WTI hit their highest in a month. And even though U.S. shale producers are pumping crude like crazy and adding to supply, hedge funds see reduced drilling as a sign of lower production next year. 

Hedge funds aren’t going full-on bull, their net-long positions are still a lot lower than they were a couple of months ago, but they’re counting on economic improvement from a trade war reprieve, and it’s taking them out of oil’s bearish playground. 

The net long position for hedge funds is the difference between bullish and bearish bets. And on Monday, Bloomberg reported that money managers’ WTI net-long position rose 11 percent in the week ended November 5th, as did net bullish wagers on Brent. 

Here are three scenarios that could support higher oil prices in the near-and mid-term:

#1 China Deal

The long-running trade war between the world’s two biggest economies has brought about a general malaise to the global economy. 

Negotiations between Washington and Beijing have been long, intermittent and protracted with plenty of bad blood from both sides. The situation got so choppy at one juncture that it took top U.S. negotiator Robert Lighthizer reading China the riot act to get the broken talks back on track. Related: U.S. Shale Is Far From Dead

They say all’s well that ends well - finally, there seems to be some light at the end of the tunnel after the Trump-led team announced they have finalized ‘Phase One’ of the trade negotiations.

In the interim deal, the warring nations agreed to a phased rollback of extra tariffs. 

While far from being the ideal solution, investors such as private equity billionaire David Rubenstein believe it will be enough to relieve economic tensions for the next year or so.

Back in August, Helima Croft of RBC Capital Markets predicted that a China deal could support WTI price in the $60-$66 range. That’s nearly 12 percent higher at the mid-point than Monday’s close of $56.50.

Oil markets have so far remained indifferent, underlining just how much damage the trade spat has wrought on the global economy. 

Maybe all those platitudes about confidence bouncing back after an initial deal were a touch optimistic.

#2 Geopolitical Risk

Rising geopolitical risks, particularly in the Middle East - home to more than 60 percent of the world’s oil reserves - is bullish for oil, theoretically.

Tensions between Iran and Saudi Arabia reached a boiling point following the September 14th attacks on Aramco’s oil facilities. 

Meanwhile, the New Iran Deal remains a highly emotive issue - especially since Iran, in a fresh act of defiance, has kicked off another round of uranium enrichment work at its Fordow site. The International Atomic Energy Agency will release a new report this week that will clarify whether Iran has been complying with its commitments.

The European Union is desperate to forge a new nuclear deal with the Islamic Republic to replace the 2015 deal that Trump scuttled last year. The EU is trying to create a Special Purpose Vehicle that will help the bloc circumvent U.S. sanctions and continue buying Iranian oil. So far, it’s clear the sanctions are working, with oil exports from Iran on a continuous decline.

In the highly likely event that Trump and his European allies are unable to forge a new deal, tensions between Iran and Saudi Arabia are likely to escalate. 

A week ago, the UAE unveiled Edge, a defense conglomerate that will focus on cyberattacks and repelling military attacks in the wake of the Aramco attacks. Iranian saboteurs will, therefore, have their work cut out for them if they try to launch another attack on a scale anywhere as big as the last one. 

While chances of an all-out war with the US or Saudi Arabia appear slim, tensions in the region are likely to remain high and increase the supply risk.

#3 Declining inventories and rig count collapse

In late October, oil prices surged 3 percent after the U.S. Energy Information Administration reported a surprise decline in US crude inventories. The EIA reported that crude inventories fell by 1.7 million barrels, while gasoline stockpiles fell more than forecast.

The organization revealed that on a seasonal basis, gasoline demand in the United States has been at its highest since at least 1991.

Meanwhile, U.S. oil rig count has been trending south for many months now. Related: The World’s Biggest EV Market Braces For Another Crippling Blow

The latest Baker Hughes report showed a decline of 5 rigs from the preceding week to 817, and a massive fall from the 1,057 rigs reported at a corresponding point last year. 

So far, production has continued to rise amid the rig count collapse only because drillers are focusing on bringing the considerable fracklog of uncompleted wells online. Obviously, this can only go on for so long, and at some point, production is bound to get compromised. 

A significant decline by the world’s biggest oil producer is very likely to impact oil prices in a positive way, though this is unlikely to happen in the near future.

Bullish Bottom Line: 

There are different ways to be bullish on oil. You don’t have to go full bull and take big long-term positions. Right now, it’s the perfect time to play the short-term buy and sell game, buying on the dip and selling on the spike, as long as WTI is trading at a bottom range of between $49 and $55. In other words, you can be a trading bull without being an investing bull as long as crude stays in its current trading range, which is already more attractive than it was last year. 

By Alex Kimani for Oilprice.com

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Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com.  More

Comments

  • Mamdouh Salameh - 12th Nov 2019 at 3:07am:
    Whilst the fundamentals of the global oil market are positive as manifested by China’s soaring crude oil imports, there is one pivotal bearish factor that has been depressing the growth prospects of the global economy and also the global demand for oil and prices. This factor is the continued trade war between the United States and China which has been going on for almost two years.

    The trade war has widened an already existing glut in the market from a relatively manageable 1.0-1.5 million barrels a day (mbd) before the war to an estimated 4.0-5.0 mbd. This glut has been big enough to nullify the impact of geopolitics on oil prices and also absorb a loss of 5.7 mbd from Saudi oil production.

    Even a small initial agreement between the two titans to a phased rollback of extra tariffs could stimulate global economic prospects and enhance the global demand for oil and therefore prices.

    Only when the glut in the market starts to decline significantly to pre-war levels will the geopolitical factor kick off.

    Another long term bullish factor is emerging with the confirmed slowdown of US shale oil production. Despite a lot of hype by the US Energy Information Administration (EIA) about rising US shale oil production, the truth is that shale oil production is slowing down so fast that US oil production will amount to 11 million barrels a day (mbd) or less this year and not the false figure of 12.6 mbd that the EIA has been peddling.

    Baker Hughes rig count is a pivotal indicator of the state of the US shale oil market. Rig counts don’t lie. They tell the truth as it is on the ground. The fall of rig count in Texas and the fact that Texas is home to the Permian which accounts for 60%-70% of total US shale oil production confirm a steep slowdown in US shale oil production and a lot of bankruptcies among US drillers. Shale oil will be no more in 5-10 years.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
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