Market Headed for "Big Trouble" Due to Rising Shale and No Evidence of Positive Impact from OPEC Production Cuts

Tuesday March 7, 2017

More bad oil news came in the form on Monday of reports that hedge funds reduced wagers that U.S. oil prices will rise - an indicator that the market is becoming vulnerable for a drop, and completely eradicating the earlier bullish sentiment based on hopes that the Organization of the Petroleum Exporting Countries (OPEC) would make a dent in the global supply glut via its cutback initiatives.

Hedge funds trimmed their net-long position on West Texas Intermediate by 6.5 percent in the week ended February 28, according to U.S. Commodity Futures Trading Commission data.

Michael Lynch, president of Strategic Energy & Economic Research, summarized the situation for Bloomberg by remarking, "They've gone so far on hopes and dreams; I’m worried they’ve overdone it, since we haven’t seen much happen with measures that would support the market - i.e. inventories."

Stephen Schork, president of Schork Group Inc., agreed: "The market is very long and very vulnerable; they are trying to wait out the turnaround season, which will be over in a month, and are betting OPEC will continue to pull back barrels."

Fundamentals show that there is good cause to worry: Baker Hughes reported that U.S. producers added more rigs last week, extending their drilling surge into a 10th month; this caused Bill O’Grady, chief market strategist at Confluence Investment Management, to point out that "If we don’t start to get big inventory draws soon this market is in big trouble.

"This will only work if the Saudis continue to make cuts to justify prices."

Presumably, temporary setbacks to production in other countries, such as in Libya where Benghazi Defense Brigades militia have seized the Es Sider terminal, are not enough to slow the market problems caused by the U.S. as well as by Middle Eastern producers such as Iran and Iraq who have demonstrated little or no interest in abiding by the OPEC cutback agreement.

But even though it seems that oil is truly range bound after WTI on Monday slipped 5 cents to settle at $53.20, some experts insist that won't be the case in the long term: the overall message of the International Energy Agency at the CERAWeek energy conference is that oil prices are set to rise sharply starting in 2020 if new energy investments are not made this year.

Fatih Birol, chairman of the IEA, remarked, "We have seen two years in a row of huge declines in upstream investment; if this is the case in 2017, if we don't see substantial rebound, we may well see that the market tightens around 2020 and the spare production capacity shrinks."

Earlier this month, Gene McGillian, manager of market research at Tradition Energy, said, "Without full compliance by the OPEC cartel and non-OPEC producers, and signs that demand is picking up, we are positioned for a correction."

He added, "There's a risk that some of the new longs will start to head for the exits, and that's where we could see a correction."