Saudi's holiday clearance sale

December 3, 2015 09:25 AM

What should you get that special someone this holiday season? How about some oil?

Saudi Arabia is slashing prices to crazy levels in a wild and crazy holiday sale! Saudi Arabia is pricing oil to move to all of their U.S. buyers ahead of the OPEC meeting. Don’t miss this opportunity to lock in some of the lowest prices this decade before the prices go up again!

Despite all the rumors of a possible OPEC production cut, a move by Saudi Arabia to put oil on sale sent a strong message this holiday season. The Saudis will go all out to protect market share. After an early morning oil price spike on a misinterpreted story saying that Iran reported that OPEC had agreed to a production cut, oil prices tanked.

Not only did the market have to deal with a slightly bearish oil inventory report, but it also had to deal with the report from the International Atomic Energy Agency that probably opens the door for the lifting of U.S. sanctions on Iraq. Yet the most bearish story yesterday was the Saudi price cut because the market is so focused on whether or not OPEC will cut production when they meet in Vienna on Friday.

The message that they are sending is that they will agree to cut production as long as it will be coordinated with other non-OPEC members. Obviously this means Russia, Mexico and Oman, but in light of the Saudi cut in prices to U.S. buyers it may also mean U.S. oil shale producers. The latest rumor that is bringing up prices a bit is that the Saudis will cut production by about a million barrels—assuming that other OPEC and non-OPEC  producers will comply, although probably not at this meeting but at the next year. Of course, that is a big if.

To gauge the importance of the question of a production cut and the mood of the market, let's replay yesterday’s big moves to show you the mood of the market.

Oil prices spiked almost a dollar just after 9.00 am Central time on Dec. 2 after a headline that said that OPEC had agreed to a production cut. Yet the spike was short after details of the story came out. The Iranian News source “Shana” caused the spike when they reported that “a majority of member states of the Organization of Petroleum Exporting Countries (OPEC) agree on a reduction in the crude oil production.”

If you read on they say “with an exception of Saudi Arabia and Persian Gulf Arab countries,” which is a big exception and the reason the price quickly came crashing back down. Then came the Energy Information Administration (EIA) inventory report that was bearish, but not really that much more bearish than the American Petroleum Institute version. The EIA said that commercial crude inventories increased by 1.2 million barrels last week, a total inventory of 489.4 million barrel still at an 80-year high. That dipped oil back below $41, but then it looked like it might recover because of a strong gasoline demand number.

But then came the Saudi price cut report. That sank the market because at least yesterday that was a sign that the Saudis had no intention in cutting production. In fact, it's just the opposite. Saudi Aramco cut the price of all its crudes for U.S. buyers for January and also deepened the discount for its Arab Light grade in Asia. Bloomberg reported that the premiums for Extra Light and Arab Light to the U.S. were decreased while discounts for medium and heavy were slashed even further.

Arab Light sales to Asia were cut by 10¢ to $1.40 below a regional benchmark. The Saudis are going all out to undercut U.S. shale producers to try to slow that resilient U.S. oil output. While U.S. oil production fell in September for the third month, it is still running at an impressive 9.326 million barrels a day. That is down 20,000 barrels a day from August.

Oil also was pressured by the fact that the much anticipated lifting of sanctions on Iran will actually happen. The Wall Street Journal reports that the Obama administration said it expects to start lifting sanctions on Iran as early as January after the United Nations' nuclear watchdog found no credible evidence that Tehran has recently engaged in atomic weapons activity.

That presents a problem for a production cut next year as well as the Iranians feeling that they are entitled to regain lost market share because of the sanctions. The bottom line comes down to this: If it seems that OPEC along with the Saudis will agree to a possible roadmap to a production cut, then oil may see a significant rebound. If not, the lows will be tested as well as the bulls’ staying power.

In the big picture, oil is in the bust end of the cycle, and when you hit bottom there is no place to go but up. The question is if we are at the very bottom or if it is going to take more time and another significant price drop to get there. The best way to play it is to look down the curve a few years out and use long term protected strategies to take advantage of this super Saudi holiday oil sale. While price may go lower they won’t stay here forever because global demand will continue to grow against a historic pullback in energy capital spending. Happy Holidays from your friends in the OPEC cartel.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.