Since 1984, Welsh singer Bonnie Tyler has been holding out for a hero. She has evocatively brought to song the persona of the damsel in distress. In the darkest of nights, when the situation is grim and you have lost all hope, you too may find yourself wishing for the intervention of somebody so selfless, so courageous, that they risk everything to rescue you from your predicament. Unfortunately, that would also imply that you have gotten yourself into a situation that is so dire and desperate that your only way out is through the actions of someone like Horatius or Audie Murphy. Many an oil investor today, desperately clinging to his length, hounded by relentless bears, could find himself humming under his breath:
“Where has all the bull talk gone
And where are all the bids?
Why have excess supplies
Got the market on the skids”
While you may be glad I do not sing you surely have to admit that oil prices, at the moment, could use a hero and all eyes are set in one direction: Saudi Arabia…
“Isn’t there a white Sheikh upon a fiery steed?
My returns keep going down
And a rally is what I need!
…I need a hero!”
Heroes do the heroic stuff because they care for those they protect. Horatius stood alone at the bridge against fearful odds out of patriotism and love for Rome. Saudis today do not care for the oil bulls. They make sense when they refuse to cut production, and the reason for which they will continue on this course is simple: They are winning! Their strategy is to get rid of less efficient competitors, and low oil prices are starting to have an effect. Slowly but surely, Shale oil production is going down. Expensive, hard to reach oil fields, like those in Brazil or the arctic are being abandoned. Why would the Saudis change their mind? Here is what the bulls would argue:
- They need US$ 100 to balance their budget: That may be true, as no one knows what their budget really looks like, but they have large cash reserves and they can borrow, so they could hold on for quite a while even with lower prices. In reality, I have to find this argument laughable. Analysts use this argument for Saudi Arabia being under duress, when France, the UK, Japan Italy and the US are all miles away from going anywhere near a balanced budget. Do you see them changing their ways?
- Continued low prices will stifle investment and create a future price spike. Are you kidding? The very reason for which OPEC continues to produce and keep prices down is to stifle investment and create a future price spike. It is their objective, not an inconvenience.
- Some other country will convince them. How? Which country has the trust / leverage / influence necessary to get the Saudis to change their ways? Most importantly, the Saudis would immediately see that any country that tries, like Venezuela, has ulterior motives.
The Saudi government is devoted to only one cause: itself. It will do what is necessary to protect the nation’s economy. In fact, one could argue that they are already being heroic, braving low prices, to ensure a better future for themselves. Why they would sacrifice themselves for the Russian economy, or investors who are long oil is beyond me. So it’s simple, OPEC and the Saudis will continue on course, until they win. In fact, OPEC production increased by 110,000 barrels a day in September, while Iraq is forecasting further increases in production for next year. The Iranian parliament has passed the nuclear deal, and they will soon be back on the market. Even Mexico, which is not in OPEC, has declared it will not cut production. They are all rational and with a continued surplus of 2 million barrels, they know any cuts would just be market share given away to someone else.
Some of you may not believe this reasoning. Some of you may think my theories don’t make sense… Well, as luck would have it, you only have to look at the Copper market to see a similar situation. Both Rio Tinto and BHP Billiton have come out this week to announce they would be ramping up production. The financial times, which reported on both companies, stated “it would be illogical to hold back output and leave space in the market for higher-cost rivals”. You might respond that Glencore is cutting zinc production… and you’d be missing the point: Glencore IS one of the higher-cost rival. So there will be no self-sacrificing heroics in the copper market either.
On the demand side, there was also some hope for change. We have been mentioning that point repeatedly. In fact, we are probably one of the most optimistic in predicting when the turnaround will be fully underway. We believe the 2016 driving season will be the time to get bullish again, while many are predicting that 2017 will see better prices as increasing demand reduces excess supply. This in no way means you should go long now. As we said last week, it is way too early. To underscore how early it is, the IEA has now forecast that the rate of oil demand growth will slow down next year from this year’s 1.8 million barrels per day to 1.2, on the back of continued global economic worries and bad statistics coming out of China. So even our prediction could be too early!
Looking at the markets in general, we must admit we are concerned. It seems to us that all bullish strategies at the moment hinge on some form of heroic intervention or a Deus Ex Machina moment. Out of the blue, someone will come to the rescue. Oil is waiting for OPEC, Metals are waiting for BHP, Equities and treasuries are waiting for the FED… Isn’t there a sound strategy left out there?
Since we are on the subject of heroics, we hope you all followed our advice not to get on the oil rocket last week. Prices have been dropping since Monday, and this week, the EIA has reported a 7.56 million barrel increase in stocks. This was bound to happen eventually as refiners come down for maintenance. Prices have now given up all of last week’s gains and there is likely more where that came from keeping in mind stocks should build for the next 4 to 6 weeks. We are still Long Brent against WTI, except we have rolled it into December. We still believe this should at least go to US$ 4 in favour of Brent. We are still short Nov Dec WTI and we will keep the position as we thing it will deteriorate at expiry from the 55 cents it currently orbits around. Contango will deepen and the physical market is looking worse and worse. US$ 32.20 on WTI remains our target for the maintenance period.
Distillate stocks have declined 1.52 million barrels this week, which is seasonal considering maintenance. Production still outpaces consumption though, and exports to Europe are ongoing. The result is that margins are dropping and are now almost at US$ 16 per barrel. We missed that sale, but we felt and still feel it is better to be prudent for now.
Gasoline stocks declined 2.62 million barrels and to some extent are in the same situation as distillates. Stocks are declining, but production is ample, so the refining margin now sits at US$ 8.4 and this being maintenance period, it looks like a purchase. Since December crack looks better at 8.25, we decided to buy that instead. Hopefully, crude stocks will increase while gasoline decreases favouring our position.
Refining is now well in maintenance, but it looks like enough is still running to amply cover the US and continue exports. As we had surmised, the bulls are now stuck between rapidly growing crude stocks and relatively small reductions in products. This winter could very well be awash with product.
You will find below our usual graphs. These represent the evolution of stock levels for Crude oil, Gasoline and Distillates (heating oil, diesel and Jet fuel) as well as refinery crude runs. The graphs show the current year against the High/Low range of the preceding five years. These are published by the EIA on a weekly basis, and are used by traders the world over to try and assess Supply and demand. The scale is in thousands of barrels over the 52 weeks that make up the year.
US CRUDE STOCKS
US Commercial Crude Stocks… Going into space again? (Source: EIA)
US CRUDE RUNS (Refining)
US Refining… coming down (Source: EIA)
US DISTILLATE STOCKS
Distillates Stocks… seasonal (Source: EIA)
US GASOLINE STOCKS
Gasoline Stocks…high… (Source: EIA)
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