Oil has come a long ways, in really short order, rising from $26.21 on February 11 to over $38 as of March 31 (a 46% increase).
Hedge funds have become “as bullish on crude as they’ve ever been, according to the latest CFTC data,” said CNBC’s Melissa Lee on Wednesday.
Is the bullishness justified? Let’s try to sort all this out.
To start, here’s video of a Lee’s and Timothy Seymour’s CNBC interview of PR Advisors founder Robert Raymond. To me, Raymond’s analysis makes a lot of sense. See what you think. I’ve excerpted several statement from Mr. Raymond, followed by my comments (labeled Feik) to give you my view.
Raymond: “(The bullishness) is actually part of what has us concerned.”
Feik: I agree. John Templeton provided a favorite investing maxim of mine (and of many others) when he said, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” With so many people trying to bottom-fish in oil and energy right now, I don’t see the kind of pessimism or skepticism that sparks bull markets. So, like Mr. Raymond, that has me concerned.
Raymond: “(We’ve seen) a massive short squeeze in the oil market where the net length of the futures contracts outstanding have gone way up, to a record level of almost 365,000 contracts, but the real reason for that is because of 200,000 contracts covered on the short side as opposed to actually real length added on the long side.”
Feik: Right. That’s just a little more data to support my own skepticism about oil’s 46% rally since Feb. 11th.
Raymond: “What becomes interesting is while the front end of the curve has rallied a lot, the back end hasn’t really moved that much. I think... we’re going to find out there’s been a massive amount of hedging in the 2016 and 2017 calendar strips, as a lot of the producing community is using this rally as a way to effectively lock in prices and also begin completing a bunch of drilled and uncompleted wells.”
Feik: Basically, Raymond sees headwinds for oil prices in the near term due to technical factors like short-covering, and also fundamental factors like how producers seem to be responding to the price increase by scurrying to put hedges in place to protect their ability to sell in the $40s instead of the $30s or $20s, and also by ramping up (or preparing to ramp up) wells they feel can quickly produce some revenue... which of course, adds to supply, thereby tending to hold prices down. Makes sense to me.
Raymond then discussed differences between his short-term and long-term outlooks for oil. First, the short term (emphasis added):
Raymond: “What really ultimately drives crude price is the level of inventory. There’s a strong degree of correlation historically. The disconcerting part of that is, in the very near term, in the last 6 weeks we’ve put another 30 million barrels of crude oil in inventory. So we’re not seeing the structural fundamental dynamics that ultimately drive prices substantially higher. So we think this (recent rally) has been more technical than fundamental.”
Feik: Interesting perspective! Again, I think Raymond’s analysis seems sound. Perhaps he’s correct that most of this recent rally has been driven by technical factors rather than fundamental ones, since we just learned on Wednesday that inventories have in fact continued rising.
Now, as for the long term:
Raymond: “As we get longer out there in 2017 and ’18, we have frankly a more constructive view of the environment. We’re just cautious in the relatively near term, measured in days, weeks, maybe a few months.”
Feik: Well, I don’t feel I can predict 2018 anyway, but again, I generally agree with Raymond’s assessment that oil probably faces headwinds in the near term. Before becoming very bullish again on oil, I’d like to see investors become much more skeptical or even pessimistic (which may require another crash, to the point of capitulation). Either that or I’d love to see evidence that inventory meaningfully declines for a while, which remains the opposite of the current trend.
Which brings me to Mr. Trump.
Trump, during an interview on foreign policy published by the New York Times last Saturday, made some provocative statements (No! Trump, provocative? He’d never do that) in regards to US imports of Saudi Arabian oil. From the NYT transcript, one of the NYT interviewers, David Sanger, asked, “Would you be willing to say, ‘We will stop buying oil from you, until you send ground troops?’” Here are excerpts from Trump’s response:
“Probably yes, but I would also say this: We are not being reimbursed for our protection of many of the countries..., including Saudi Arabia.
“Oil has gone down, but still... the amount of money (the Saudis) have is phenomenal. But we protect countries and take tremendous monetary hits on protecting countries. That would include Saudi Arabia, but it would include many other countries. Without us, Saudi Arabia wouldn’t exist for very long.
“So,... I would say at a minimum, we have to be reimbursed. Because we’re not being reimbursed for the kind of tremendous service that we’re performing by protecting various countries. I think if Saudi Arabia was without the cloak of American protection... I don’t think it would be around… for very long. And they’re a money machine,... and yet they don’t reimburse us the way we should be reimbursed. So that’s a real problem.
“We will not be ripped off anymore. We’re going to be friendly with everybody, but we’re not going to be taken advantage of by anybody."
Wow, fun argument for an energies article, right?
My take is this: First, if the US were to impose sanctions banning Saudi oil imports (which admittedly is just a lot of rhetoric right now, but just to humor the idea for a minute), the Saudis would simply sell the commodity elsewhere.
Saudi oil ministers and executives have said as much. “Every barrel of oil produced by Saudi Arabia has a well-known buyer and will not remain unsold," Othman Khwaiter, vice president of Aramco said in the Tuesday’s Arab News.
Basically, the Saudis’ attitude about Trump’s blustering has been, “Go ahead, make my day.” Call them Sandy Harry (not “Dirty”... get it? Ha ha).
My next point is this: We’ve already decreased our Saudi imports from about 1.45 million barrels per day (mbd) in 2005 to about 1.05 mbd in 2015, according to the Energy Information Administration (EIA). The decrease has been driven by market forces; namely, the shale revolution. In fact, Trump’s own words give a nod to free market’s victory, as follows:
“The beautiful thing about oil is that, you know, we’re really getting close, because of fracking, and because of new technology, we’re really in a position that we weren’t in, you know, years ago, and the reason we’re in the Middle East is for oil. And all of a sudden we’re finding out that there’s less reason to be.”
Just to give you perspective, the US consumes about 19.5 mbd, according to the EIA. As stated, we import about 1.05 mbd from Saudi Arabia. Saudi imports made up about 14.3% of US oil imports in 2015. The largest foreign supplier of oil to the US is Canada, which provides over 43% of our oil imports.
So wait. If Saudi Arabia supplies only 1.05 mbd of our 19.5 mbd consumption, do we really need them anymore anyway, you may ask?
Couldn’t US producers simply ramp up some of the wells we’ve shuttered in recent months, and produce all our oil domestically?
Unfortunately, not yet. A major limitation is that most US oil refineries (the folks who buy the oil for processing into fuels and other products) are set up – ironically – to handle heavy sour crude. These refineries aren’t able to handle the type of light sweet crude produced domestically. Changing over or building new refineries would be a long, expensive project. And don’t ask me how they know if the crude tastes sweet or sour.
Bottom line, though, is that without Saudi oil, the US currently would probably have to import oil from elsewhere... which could be problematic, in light of our other options. For example (besides Iran), our #3 and #4 import suppliers are Venezuela and Mexico, both of whom are having a hard time producing sufficient quantities to export, according to Robert Rapier at Investing Daily.
It’s an interesting dilemma, and one that I trust will sort itself out in the marketplace over time. As for Trump’s proposed government-mandated boycott, I don’t suppose it’s a very conservative idea. Libertarians are surely not impressed. And besides, can you really imagine Saudi Arabia saying, “Okay, President Trump, you win. We want so badly to sell our oil to the US instead of to other countries that we’ll go ahead and send our young men to risk their lives fighting ISIS.” Hardly. I’ll tip my hat to Trump for at least raising ideas and thinking creatively to make the point that everyone needs to pitch in and contribute to today’s global war on terror. I think most Americans would agree the US shouldn’t have to bear the burden alone.
Your comments are welcome.
Best,
Adam Feik
INO.com Contributor - Energies
Disclosure: At the time of post publication, this contributor did not own any other stock mentioned. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
