OPEC just about gets the basics right

On occasion, signs around Austrian bars and shops selling souvenirs humorously tell tourists to get one basic fact right – there are no kangaroos in Austria! In more ways than one, last week’s OPEC meeting in Vienna was also about getting its 12 member nations to recognise some basic truths – not so much about the absence of marsupials around but rather about  surplus oil in the market.

Assessing demand, which is tepid in any case at the moment, comes secondary when there is too much of the crude stuff around in the first place. Of late, OPEC has become just a part player, albeit one with a 30% share, in the oil market’s equivalent of supermarket pricing wars on the high street, as the Oilholic discussed on Tip TV. Faced with such a situation, cutting production at the risk of losing market share would have been counterproductive.

Not everyone agreed with the idea of maintaining production quota at 30 million barrels per day (bpd). Some members desperate for a higher oil price were dragged around to the viewpoint kicking and screaming. Ultimately, the Saudis made the correct call in refusing to budge from their position of not wanting a cut in production.

Though ably supported by Kuwait, UAE and Qatar in his stance, Saudi Oil Minister Ali Al-Naimi effectively sealed the outcome of the meeting well ahead of the formal announcement. Had OPEC decided to cut production, its members would have lost out in a buyers’ market. Had it decided on a production cut and the Saudis flouted it, the whole situation would have been farcical.

In any case, what OPEC is producing has remained open to debate since the current level was set in December 2011. The so-called cartel sees members routinely flout set quotas. In the absence of publication of individual members’ quotas, who is producing what is never immediately ascertained.

Let’s not forget that Libya and Iraq don’t have set quotas owing to leeway provided in wake of internal strife. All indications are that OPEC is producing above 30 million bpd, in the region of 600,000 barrels upwards or more. Given the wider dynamic, it's best to take in short term pain, despite reservations expressed by Iran, Venezuela and Nigeria, in order to see what unfolds over the coming months.

After OPEC’s decision, the market response was pretty predictable but a tad exaggerated. In the hours following Secretary General Abdalla Salem El-Badri’s quote that OPEC had maintained production in the interest of “market equilibrium and global wellbeing”, short sellers were all over both oil futures benchmark.

By 21:30 GMT on Friday (the following day), both Brent and WTI had shed in excess of $10 per barrel (see right, click to enlarge). That bearish sentiment prevailed after the decision makes sense, but the market also got a little ahead of itself.

The start of this week has been calmer in part recognition of the latter point. Predictions of $40 per barrel Brent price are slightly exaggerated in the Oilholic’s opinion.

Agreed, emerging markets economic activity remains lacklustre. Even India has of late started to disappoint again after an upshot in economic confidence noted in wake of current Prime Minister Narendra Modi’s emphatic election victory in May. Yet, demand is likely to pick-up gradually. Additionally, a price decline extending over a quarter inevitably triggers exploration and production (E&P) project delays if not cancellations, which in turn trigger forward supply forecast alterations. 

This could kick-in at $60 and provide support to prices. In fact, it could even be at $70 barring, of course, the exception of a severe downturn in which case all bets are off. Much has also been said about OPEC casually declaring it won’t convene again for six months. Part of it fed in to market sentiment last week, but this blogger feels saying anything other than that would have been interpreted as a further sign of panic thereby providing an additional pretext for those going short.

Let’s put it this way - should the oil price fall to $40 there will definitely be another OPEC meeting before June! So why announce one now and create a point of expectation? For the moment, OPEC isn’t suffering alone; many producers are feeling different levels of pain. US independent E&P companies (moderate), Canada (mild), Mexico (moderate) and Russia (severe) - would be this blogger's pain level call for the aforementioned.

The first quarter of 2015 would be critical and one still sees price stabilisation either side of the $70-level. One minor footnote before taking your leave - amidst the OPEC melee last week, a client note from Moody’s arrived into the Oilholic’s inbox saying the agency expects Chinese demand for refined oil products to increase by 3%-5% per annum through 2015. This compares to 5%-10% in 2010-2012.

It also doesn’t expect the benchmark Singapore complex refining margin to weaken substantially below the level of $6 per barrel because lower effective capacity additions and refinery delays will reduce supply, while “the recent easing in oil prices should support product demand.” That’s all for the moment folks! Keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.
To follow The Oilholic on Google+ click here.
To follow The Oilholic on Forbes click here.
To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo: No Kangaroos in Austria plaque Graph: Weekly closing levels of oil benchmark prices since Oct 3, 2014 to date* © Gaurav Sharma.

Oil, Tip TV & a ‘timely’ Bloomberg report

Brent continues to slip and WTI is along for the slide-ride too. Over the last two weeks, we’ve seen price floors getting lowered only to be breached again sooner than most expect. The Oilholic’s latest 5-day assessment saw both benchmarks as well as the OPEC basket of crudes end the week below US$90 per barrel on Friday.

One has been putting forward a short position argument on Brent since the summer to the readers of this blog and in columns for Forbes. As the tale goes, yours truly has pretty much got the call right, except for a few weeks over one month. Speculators, including but not limited to hedge funds, triumphed in June using the initial flare-up in Iraq as pretence for driving the futures price up. Market fundamentals were never going to support a price spike to $115, as was the case back then.

Those banking on backwardation were bound to get left holding barrels of paper crude on their books that they never needed in the first place for anything other than trading for profit. As the date of the paper contract got desperately close to where you might have to turn up with a tanker at the end of a pipeline, hedge funds that went long in June ended up collectively holding just shy of 600 million paper barrels on their books.

Smart, strategic buying by physical traders eyeing cargoes without firm buyers made contango set in hitting the hedge funds with massive losses. The week to July 15 then saw hedge funds and other speculators cut their long bets by around 25%, reducing their net long futures and options positions in Brent to 151,981 from 201,568 according to ICE.

Physical traders, had finally taught paper traders a long overdue lesson that you can’t cheat market fundamentals for very long. So it was a pleasure expanding upon the chain of thought and discuss other ‘crude’ matters with Nick 'the Moose' Batsford and his jolly colleagues at Tip TV, on October 6. Here’s a link to the conversation for good measure. 

Overall dynamic hasn’t altered from May. To begin with, of the five major global oil importers – China, India, Japan, US and South Korea – importation by four of the aforementioned is relatively down, with India being the odd one out going the other way. Secondly, if an ongoing war in the Middle East is unable to perk-up the price, you know the macroeconomic climate remains dicey with the less said about OECD oil demand the better.

Thirdly, odd as it may seem, while Iraqi statehood is facing an existential threat, there has been limited (some say negligible) impact on the loading and shipment of Basra Light. This was the situation early on in July and pretty much remains the case early October. There is plenty of crude oil out there while buyers are holding back.

Now if anything else, hedge funds either side of the pond have wised up considerably since the July episode. Many of the biggest names in the industry are net-short and not net-long at present, though some unwisely betting on the ‘only way is long’ logic will never learn. Of course, Bloomberg thinks the story is going. One has always had a suspicion that the merry team of that most esteemed data and newswire service secretly love this blog. Contacts at SocGen, Interactive Brokers and a good few readers of ADVFN have suggested so too.

Ever since the Oilholic quipped that hedge funds had been contangoed and went on to substantiate it on more than one occasion via broadcast or print, this humble blog has proved rather popular with ‘Bloomberg-ers’ (see right, a visit earlier this week). Now take this coincidental October 6 story, where Bloomberg claims "Tumbling Oil Prices Punish Hedge Funds Betting on Gains."

Behind the bold headline, the story doesn’t tell us how many hedge funds took a hit or the aggregate number of paper barrels thought to be on their books. Without that key information, the story and its slant are actually a meaningless regurgitation of an old idea. Let’s face it – ideas are not copyrighted. Some hedge fund somewhere will always lose money on a trading call that went wrong, but what’s the big deal, what’s new and where’s the news in the Bloomberg story? Now what happened in July was a big deal.

The 4.1% jump in net-long positions as stated in the Bloomberg report, only for the Saudis to adjust their selling price and cause a further oil price decline, does not signify massive blanket losses for the wider hedge funds industry. Certainly, nothing on July’s loss scale has taken place over the last four weeks either for the WTI or Brent, whether we use ICE or CFTC data.

So here’s some advice Bloomberg if you really feel like probing the matter meaningfully. In the style of Mr. Wolf from Pulp Fiction, if the Oilholic “is curt here, it’s because time is a factor” when putting these things together, “so pretty please with sugar on top” - 

(a) Try picking up the phone to some physical traders of the crude stuff, as price aggregators do, in order to get anecdotal evidence and thoughts based on their internal solver models, not just those who pay way too much for expensive data terminals and have never felt or known what a barrel of crude oil looks like. It'll help you get some physical market context. 

(b) Reconcile at least two months of CFTC or ICE data either side of the pond to get a sense of who is electronically holding what. 

(c) Take the aggregated figure of barrels held at a loss/profit to previous month as applicable, be bold and put a round figure estimate on what hedge funds might well be holding to back up loss/profit slant.

Or (d) if you don’t have the tenacity to do any of the above, email the Oilholic, who doesn’t fix problems like Mr. Wolf, but doesn’t bite either. In the meantime of course, we can keep ourselves fully informed with news about Celine Dion’s whereabouts (see above left, click to enlarge), as Will Hedden of IG Group noted in a recent tweet – the kind of important market moving news that reminds us all how good an investment a Bloomberg terminal is! That’s all for the moment folks! Keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.
To follow The Oilholic on Google+ click here.
To follow The Oilholic on Forbes click here.
To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo 1: Shell Oil Rig, USA © Shell. Photo 2: Bloomberg's visit to the Oilholic, Oct 6, 2014 © Gaurav Sharma. Photo 3: Bloomberg Terminal with Celine Dion flashes © Will Hedden, IG Group, August 2014.