Why This Could be the Best Oil Trade Idea of 2016

In today’s Money Morning…crude climbing fast, but can it keep going?…a production freeze, but at record highs…a possible shorting opportunity this week…and more…

The crude oil price has exploded over the past week and a half. Will it hit a fresh yearly high?

I doubt it.

For months, I’ve told you that OPEC is back to its old games of manipulating the oil market. And all their talk has managed to push up the crude price. Yet if you take a step back you’ll see that’s mostly all they’ve got — talk.

Surprisingly, though, the market seems to be buying into OPEC’s jawboning.

Are we really that gullible?

Despite accurately calling crude’s breakout on 1 March, I never thought it would be trading at this level today.

Brent crude, the international benchmark, has surged to US$51.65 per barrel. That’s 86% higher than the low of US$27.83 per barrel on 20 January. At one stage on Friday, Brent traded 3 cents short of its one-year high of US$52.84.

West Texas Intermediate (WTI) is trading at US$49.54 per barrel. It’s up 90% from the low of US$26.05 per barrel on 2 February.

Crude prices surged about 15% last week.

Scratching the surface, you might believe the outlook for a further run up in oil prices has improved in recent weeks. Last week, for instance, US oil inventories fell below 500 million barrels for the first time since January. That sounds impressive…until you dig into the data from the US Energy Information Administration. This shows that over the last 16 years, the historic average has been around 328 million barrels.

Furthermore, let’s not forget OPEC’s strategic manipulation of the market. A fortnight ago, the organisation agreed to reduce production to a range of 32.5 million to 33.0 million barrels per day (bpd). It’s the first cut since 2008. OPEC’s current output stands at 33.24 million bpd — a record high.

As I argued last week, the production ‘freeze’ is barely a drop in the ocean.

OPEC normally cuts its supply heading into the northern hemisphere winter months. That’s when demand pulls back on a seasonal basis. Remember, most of crude’s restocking is done during the summer months (June to August) to prepare for the northern winter.

OPEC argues that its planned cut will help the supply and demand dynamic. In reality, it’s doing itself a favour by pumping out more crude oil than it normally would do during the winter months.

In other words, the cut won’t make a difference…even if the member nations actually abide by it. And with history as our guide, that’s quite a big ‘if’.

Watch out for this week’s ‘informal’ meeting

That sounds bad for investors going long on oil. But the story gets worse…

Reuters reported on 6 October:

‘OPEC could cut production at its late-November meeting in Vienna by another 1 percent more than the amount agreed in Algiers last month if producers reckon it is needed, Algerian Energy Minister Nouredine Bouterfa told local Ennahar TV.

He also told Ennahar that OPEC and non-OPEC members would hold an informal meeting in Istanbul on Oct. 8-13 to discuss how to implement the Algiers deal, though he did not give details about who would attend.

“We will evaluate the market in Vienna by the end of November and if 700,000 barrels are not enough, we will go up. Now that OPEC is unified and speaks in one voice everything is much easier and if we need to cut by 1 percent, we will cut by 1 percent,” Bouterfa told Ennahar in an interview to be broadcast later on Thursday.

Incredibly, this extra ‘supply cut’ is what sent crude towards its former high last week. So, let me ask you a question…

What’s 1% of 33 million barrels?

Don’t freeze!

I’ll help you out.

The answer is: 330,000 barrels.

As it stands, OPEC is looking to cut about 700,000 barrels per day. So, if we add the extra cut, OPEC would take one million barrels away from the market.

That’s not Earth-shattering by any means. And again, we’re assuming every member nation will follow through on their pledged reduction. No cheating now boys!

Anyhow, OPEC’s oil production averaged about 31.6 million barrels per day last year. Assuming it cuts one million barrels next month, the member nations would still be producing more crude than they averaged last year! Remember, that was a time when crude prices were in free-fall due to the supply issues.

While the supply story probably won’t end well for crude punters in the months ahead, watch out for this week’s ‘informal’ meeting.

If the production cut negotiations look to break down, crude could fall back to the US$40 per barrel area. That’s probably when OPEC will start talking up the crude price again.

Your takeaway: Get ready. Crude could become a great shorting opportunity this week.

Regards,

Jason Stevenson,
Resources Analyst

PS: Over the past couple of weeks, I’ve spent many hours digging through my watchlist for the best resource stocks on the ASX. The kind of stocks that could go up hundreds of percent in the months ahead. If you’re looking for stocks that could see $500 turn into $5,000 in a matter of weeks, click here.


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


Money Morning Australia