As OPEC meets in Vienna, there is more evidence that the global oil market balance is underway, even as unbalanced North Korean Leader Kim Jong Un threatens to set off a hydrogen bomb.
The oil market is waiting on OPEC and non-OPEC to give a signal about the future direction of oil production. Talk of an extension of existing production cuts is making the rounds; even talk of an additional cut of 1% is being bandied about. An additional 1% cut for OPEC should be a no-brainer because it is such a small amount and that would send the market a message that they are serious about continuing the path of making oil prices go higher. In fact, based on their current compliance rate with their 1.8 million barrels cut, even if they failed to add that 1%, the compliance on their current cuts on average is the best for any OPEC deal that they have had in recent memory.
Of course, as we have said before, OPEC cuts do matter and despite all the talk about how shale oil production was going to make up the difference, it is now being proven so. Even the Energy Information Administration (EIA) admitted that they were way over estimating U.S. shale oil production growth, something we talked about months ago. We predicted that shale oil output would not reach levels that the EIA said they would because on the ground, the reality was different. Despite the fantasy that shale oil producers could make money in the $30 to $40 range, it was not the case and now that is becoming a more accepted mainstream view than when we first started to write about it.
We also believed that the major reporting agencies were underestimating demand and over estimating supply and in every case; that has also proven to be true. While I don’t blame the reporting agencies for the mistakes because they have a tough job, those incorrect reports may have had bigger consequences not only on petroleum prices but on supply.
There is more evidence everyday about tightening supply. Yesterday I wrote about the major drop in U.S. distillate supply. A Bloomberg article took it further, talking about the tightness in global supply. They wrote, “The world’s distillate oversupply is turning into a deficit. Stockpiles at major storage hubs in the United States, Northwest Europe and Singapore have now all fallen below the five-year average in the latest data. U.S. diesel futures advanced to a 26-month high as supplies shrink ahead of the typically higher demand winter season in the northern hemisphere.”
Diesel supplies going into winter are the tightest they have been in years. Gasoline is tight as well, but not as tight. That's why we have favored long-term bullish positions in petroleum and recommend the long ultra-low sulfur diesel short RBOB gasoline spread.
Crude is still looking for an excuse to breakout to the upside and maybe OPEC can give that to us. A close above the upper presence ban could signal a sharp upside move of $5- to $10-per-barrel higher (see chart below). We have stayed solid in our long-term bullish call on oil even as false reports about rising shale oil productions and of weak global demand seemed to keep the bears in control. Yet the truth in oil may set it free. Now that demand is blowing away expectations and global inventories are now below average, the market should have to adjust.
Hurricanes caused demand destruction for natural gas last week but this week an incredible heat wave in the Midwest may make up for it next week. The EIA reported a bearish 97-billion-cubic-feet increase in supply causing a sell-off. But hold onto your hat for next week. Record demand will write a different story. Total stocks now stand at 3.408 trillion cubic feet, down 136 billion cubic feet from a year ago and only 2% above the five-year average.