Oil market remains in a battle

February 12, 2016 09:26 AM

Accept the challenges so that you can feel the exhilaration of victory.

George S. Patton

With WTI testing the Jan 20th low on Thursday and actually setting a new low on an intraday basis, talk of a production cut once again began to circulate around the media airwaves putting a temporary floor in prices. The light short covering rally started midday on Thursday is continuing into today’s trading session ahead of the long holiday weekend in the United States (Presidents' Day on Monday). For now the only consistent upside element around the oil complex is rising volatility. The CBOE Oil Volatility Index rose to the highest level since early 2009. I expect volatility to remain at elevated levels going forward.

The oil market is remains in a battle between the overwhelmingly current bearish fundamental outlook and the market rebalancing either on its own or as a result of a voluntary cut by some form of a consortium of international producers. No matter how you slice and dice the current and projected fundamental data, supply continues to outstrip demand and is projected to do so at least through the end of 2016 and possibly into early 2017 according to the IEA, EIA, OPEC and many other analysts.

Even with the low oil price environment currently in play the global oil market is not going to rebalance itself anytime soon nor is the oil complex likely to enter into a sustained uptrend in the short to even medium term. Based strictly on the current fundamental outlook, prices are likely to retest and set new lows before entering into a sustained rally. There is simply too much oil being produced with a limited number of places for it to go as storage is near the upper end of capacity in many places around the world including place like Cushing, OK. The 12-month WTI contango is at the widest level since the financial crisis back in 2009. The economics overwhelmingly support new storage trades suggesting production will keep flowing as long as there is a place to store it and still make money by storing it for later use.

With little support coming from the market rebalancing itself quickly, the market’s attention has been switching to any indication of a deal to cut production or even freeze it (latest proposal by Venezuela) by OPEC or some group of OPEC and non-OPEC producers. This would be the best outcome for oil prices to rebound in the short to medium term. However, all of the talk over the last several weeks about OPEC, Russia and any other producer group discussing production cuts has been nothing other than talk.

Nothing concrete has emerged from any group of producers. There have been attempts to jawbone or talk the market higher by suggesting something firm is close at hand by some of the producing countries that are actually in the worst financial condition… like Venezuela, Russia, etc. The one opportunity Saudi Arabia had to stand up and give an indication that they might be interested in a strategy change went by the wayside last Sunday after meeting with Venezuela. The outcome of the meet was that it was a good meeting. In oil speak that translates to Saudi Arabia saying we have no interest in an emergency meeting or entertaining a production cut.

Each time any of the discussion reaches the media airwaves it results in light, short-lived short covering rallies like we saw yesterday and into this morning so far. However, unless Saudi Arabia steps up and suggests they are truly interested in changing away from the market share strategy, the comments by other producers circulating over the media airwaves will become less and less believable by the market and the price reaction will be short lived.

For now, there are no strong signals that the global oil surplus will subside anytime soon and the market will not enter into a rebalancing pattern either due to low oil prices and/or due to voluntary cuts by a group of international producers. Thus, the overall downtrend that has been in play since the middle of June, 2014 remains the dominant trend until proven otherwise. The market remains in a pattern of searching for a price threshold where the maximum financial pain is being experienced by the producing sector. Once that price level is found the likelihood of the market entering into an accelerated rebalancing pattern will increase. The only thing known at this time is that prices trading either side of $30/bbl do not seem to be low enough to initiate an accelerated rebalancing pattern.

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