Where Does Oil Go From Here?

This last week, there was immediate wailing from the analysts as soon as the announcement went out that the Saudis and the Russians were discussing an increase of up to 1 million barrels a day in their production agreement.

Many believe that the Saudis and therefore OPEC are giving up on the production deal that has brought oil from the depths of $30 oil to trade above $70 a barrel in the benchmark Brent. To them, any relaxation in the unprecedented collective between OPEC and the Russians indicates that the deal is 'shattered'. Now, they believe that oil could be headed back to the depths it came from and are watching for OPEC to revert to its old and well-known habits of unenforceable quotas and unlimited oil production.

I say, not so fast.

Let's look at the prior indicators for this latest drop in oil prices. We knew there were indications that the Saudis had promised Trump and the U.S. that it would take care of any shortfalls caused by the abandonment of the Iranian nuclear deal and the return of Iranian sanctions.

We also knew that the Russians were eager to be a part of any slippage in production guidelines as they have no loyalty to OPEC or the global supply chain, and are without a doubt the weakest (and most surprising link) in the production deal that has held together for nearly 18 months now.

But let's do some simple math: Iranian sanctions are likely to target as much as 1.2m barrels a day from Iran, which would be more than enough to justify the 1m barrel a day increase that's being proposed. But let's be conservative and far more realistic. With Europe and much of Asia unwilling to join in new Iranian sanctions, we can estimate that more than likely only at most 300,000 barrels of Iranian crude won't find an easy home. We can move on to Venezuela, where fully 600,000 barrels a day of production has been destroyed in their economic collapse. And with Conoco-Philips now in the midst of a legal battle to recover assets, Venezuela is unlikely to see a quick restoration of production anytime soon - no matter where oil prices go.

So, there you are: Already we're at the 1m barrels a day that the Saudis and the Russians say they are looking to add back onto the global supply chain. Even if they do deliver all 1m barrels a day, that will still mean that the production guidelines would be in 100 percent compliance, instead of the 150 percent that's been evident in recent weeks. And 100 percent compliance means that global stockpiles are still draining --- FAST.

Let's add more pieces to this puzzle and look at the streaking Permian, where all U.S. production increases are coming from. There is now a clear takeaway shortfall lack of pipelines that is plaguing the play - which is helping to generate a $20 a barrel basis price discount. Add a further shortage of rig workers, and you've got to look at the projections of the EIA for U.S. production increases (of nearly 11m b/d!) for the rest of 2018 as optimistic at best.

The 6 dollar drop in oil prices from the joint Saudi/Russia announcement starts to look less like a turnaround than an opportunity.

Instead, it seems to me that this dip is prices of both oil and oil stocks is a chance to find some value at some cheap prices you're not likely to see again.

In that idea, I want us to continue to concentrate on rotating outside of the discounted Permian and into the Bakken, Scoop/Stack and Eagle Ford. Some new ideas this week, besides Marathon (MRO) and Continental (CLR) include Devon (DVN), showing good value in Scoop/Stack and even EOG Resources (EOG), which is starting to show value again finally - with still some best of breed acreage and management.