Two events this week give us some insights on how to trade the oil markets and oil stocks for the next few weeks.
First, there’s been a tremendous financial move in the oil futures market. Most energy hedge funds and other speculative non-commercial traders have been looking at the oil markets in 2017 much as I have – and betting that the OPEC production guidelines and an inevitable re-balancing of global oil supply would lead to a constructive price spike for oil. In CFTC commitment of traders’ reports, we’ve generally seen energy hedge funds with a fairly bullish stance.
Twice in the past year, we’ve seen that those bullish bets were premature and have been very instrumental in causing short-term mini price busts. If you know me, you know that I am keen on the financial inputs to oil prices, often finding them far more important than the fundamentals that underlie them.
In the last week, there’s been a flight from oil – now to the point that oil speculators, while not quite short, are at their lowest ‘long ratio’ levels we’ve seen in 2017, and nearly match those we saw in November of 2016:
(Click to enlarge)
What’s interesting is that those November levels led to a nearly ten-dollar rally in the price of crude last year – it was an important indicator of an entirely technical short squeeze of positions that occurred then, and is in the process of occurring now.
So, while oil has had a technical rally of three dollars to above $45, we should expect the short-term squeeze to dominate the very short-term trading of oil and our oil stocks – if you were waiting for a moment to improve your basis prices on some E+P players, now would be a good time.
On the other side, we saw more indication that this technical rally won’t likely translate into a bullish trend in oil – at least not yet. Pioneer Natural Resources Chairman Tim Dove reinforced the death march of U.S. shale production when he presented this week at the JP Morgan energy conference in New York.
He basically offered two insights there – One, that Saudi Arabia would be unable to withstand prices below $50 for much longer and would therefore be obliged to extend cuts themselves, perhaps another million barrels a day or more.
On this, Dove is only surely right about the unsustainability of low oil prices for the Saudis, but certainly is speculating that it will lead to even more draconian production cuts.
As for Pioneer, also not exactly raking it in with oil prices below $50, Dove didn’t see the parallels to their OPEC competition:
“We will not drill into oblivion”, Dove said, but "we can pare away and still be a growth company even in a $45 (per barrel) environment”.
Now, nobody is more cost-effective and has a lower break-even point for oil production than Saudi Arabia – nobody. So, for Dove to suggest that he somehow has the upper hand in production and profitability in this low and unsustainable oil market compared to OPEC is the major reason that we’re all here – and why U.S. oil producers continue to push for higher outputs throughout 2017 and 2018. They continue to be their own worst enemy and have been the main roadblock to higher oil prices.
So, these two events, taken together, tell me a very simple story: Oil may have found a technical bottom for now, but oil prices are unlikely to break out of their range over $52 any time soon.
Invest with these two ideas in mind.