May 31, 2017
For obvious reasons, the end of last week experienced considerable price volatility. This week got off to a much more subdued start. For the near-term, oil markets appear to be focused on global oil inventory levels, as traders await proof that OPEC-led production cuts are having an effect. OPEC and Russian jawboning is no longer sufficient to move the markets higher. Traders are “looking for … a sustained inventory destocking pattern.” This week’s U.S. oil inventory reports are the next opportunity for market direction to be determined.
After last Thursday’s OPEC meeting and cutback agreement extension decision, the oil markets fell strongly and rapidly. You may be interested to know what occurred to cause prices to drop. Many crude traders were concerned that OPEC ministers might surprise the market with deeper production cuts than those currently in place. So, they “closed out short positions [bets that prices will fall] and bid up prices in advance of the meeting. OPEC and non-OPEC ministers signaled repeatedly that a rollover was the most likely outcome of the meeting, but there was always the possibility, however small, of a deeper cut. Once the threat of a deeper cut was removed and the rollover was confirmed, many of those long positions became unnecessary and were liquidated. The simultaneous attempt to liquidate many long positions at the same time and create fresh short positions resulted in a classic crowded trade.”
The reduced output “agreement specifically referenced production,” which is what comes out of the ground and goes into domestic consumption, exports and storage. However, lately Saudi Arabia has been claiming that output is actually supply, which is comprised of domestic consumption and exports, i.e., what goes into markets. If quotas apply to supply, producers can take unlimited oil out of the ground, as long as any volume above quota is put into storage, which allegedly doesn’t count as output. An examination of Saudi Arabia’s March numbers versus February may be helpful. Domestic consumption, exports and storage totaled +3.035mb (production). 3.150mb went into storage. Domestic consumption and exports totaled -115,000 barrels (supply). The official output number versus February was -111,000 barrels. Clearly, the Saudis did not include crude into storage in their March output number and if they had, they would have hugely exceeded their quota. Crude is not counted as output going into storage, nor is it counted as output coming out of storage. Tankage is essentially a product-laundering way station. This is how Saudi Arabia gives the appearance of cutting output, while maintaining market share by exporting crude in unchecked volumes. This is a major cause of global inventories not declining at the rate expected. In other words, Saudi chicanery is thwarting one of the primary goals of OPEC and allied producers and is threatening their credibility.