Saudi Arabia’s Grand Illusion

The House of Saud was successful last November in its year long quest to raise world Oil prices. After a few failed attempts to form a coalition of the willing, Saudi Arabia spent 6 months increasing output to unsustainable levels as part of a grand illusion. With the help of close allies they pretended to cut output by 1.2 Million barrels per day (bpd) without any real reduction. Essentially Saudi Arabia, Russia and the UAE can now produce more than they did prior to the 2014 Oil price collapse, but at prices that are more than double the 2016 crash lows. This is similar to a store doubling prices and then having a special 50% off sale to create the illusion of value. A nice trick, but they will lose in the long run as their market share will continue to erode. Yankee ingenuity should keep new US shale oil costs well under $40 in 2017, especially in the Permian Basin, ensuring a further production rebound.

An OPEC source told Reuters this week that “$60 will not encourage a big increase in (US) shale”. Yet, energy traders claim Saudi Arabia is offering discounts to all Oil buyers for April 2017 lifitngs. Is Saudi oil in need of price discounts to compete for customers? 

With a little help from Trump’s quest to escalate tensions with Iran, the Saudi’s may indeed get their wish for $60 at some point this year. However, they assume that $60 Oil will only generate new US shale output of 300,000 bpd. Since last summer the US has already added over 500,000 bpd and that number may climb to a Million in 2018 if OPEC keeps removing output. Money is already pouring into Texas, New Mexico and Canada. If over $60 Oil you can bet Dollars will also move faster into offshore drilling in the US and Mexico. OPEC is merely delaying their demise.

Without Oil prices moving back to the low $40’s, it’s hard to conceive of shrinking US Oil inventories this year. Fortunately any supply cuts to support prices will be carried by OPEC, which provides confidence for North American Oil company investments.

Crude Oil is in contango with expectations of higher prices in future months. In fact Money Managers and Hedge Funds have never been this heavily invested long in Crude and Heating Oil contracts. Such optimistic exposure requires surprising new Bullish news to keep the rally going, such as Iranian tensions with the US or any Oil country that threatens current supply forecasts. There is risk in March/April over concerns of Trumps tax reform and economic agenda stalling after being released to Congress for debate. If Trump can propose Healthcare and Tax reform that adroitly escapes the political quagmire we have come to expect, then we should all bow in shock and awe. Strong technical support in Oil resides in the upper $40’s with clear resistance at the 12 week congestion high near $55 – 56. 

Saudi Arabia pulled off the Grand Illusion that there is a growing shortage of Oil while inventories keep hitting new record level of surplus. It was a shrewd effort manipulating supplies and perceptions. Now they will have to risk further supply reductions if prices fall into the $40’s instead of their targeted $60’s. For now the trading range continues.

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