It doesn’t make sense.
The world is drowning in crude. Yet, the oil price keeps surging higher.
Will the rally end soon?
Logic says, yes.
If you’re looking at buying crude shares, I’d be cautious. In my view, significantly lower oil prices are on the cards in the months ahead.
If you want to have a punt now, I recommend avoiding the crude producers and developers. Instead, look into the best speculative oil stocks. These small companies can deliver outsized gains with a single successful drill result, regardless of whether oil is rising or falling.
As for the larger producers…
Higher prices for now
OPEC is back to its old games of manipulating the oil market.
Its crude output stood at 33.64 million barrels per day (bpd) in September — an all-time record high. Yet, before boosting production again last month, OPEC agreed to reduce production to a range of 32.5 million to 33.0 million bpd.
Even if the organisation manages to go through with this, their production ‘freeze’ won’t make a difference.
In recent weeks, I’ve discussed the story in detail. In short, OPEC normally cuts its supply heading into the northern hemisphere winter months. That’s when demand pulls back on a seasonal basis. Also, the ‘cut’ would still see the organisation produce more crude than last year.
Yet, despite the potential devastation on the cards, OPEC has managed to talk up the crude price in recent weeks.
Brent crude, the international benchmark, has surged to US$51.91 per barrel. That’s 86.5% higher than the low of US$27.83 per barrel on 20 January. Brent hit a new yearly high last week of US$53.71.
West Texas Intermediate (WTI) is trading at US$50.96 per barrel. WTI hit a fresh yearly high this week of nearly US$52. It’s up 95.6% from the low of US$26.05 per barrel on 2 February.
Unfortunately for OPEC, their manipulation has started to prove counter-cyclical. The price surge looks ready to backfire.
Crude production on the up
Reuters reported on the developments last Friday:
‘Oil settled up on Friday on hopes Russia and OPEC will reach agreement at the weekend on market support initiatives to keep crude above $50 a barrel, although traders cautioned about pressure from a double-digit rise in the U.S. oil rig count.
‘Russian Energy Minister Alexander Novak said he would make proposals to his counterpart from OPEC leader Saudi Arabia this weekend on price-supportive measures that could include an oil production freeze.
‘Some traders were skeptical about Russia’s commitment after Novak also said the country might produce up to 11 million barrels per day next year to hit a new post-Soviet record. OPEC, led by Saudi Arabia, has also been pumping crude at or near record levels.’
Look, let’s be honest here. OPEC and Russia have zero plans at cutting their production profiles in a meaningful way. They want to produce more crude, and at a higher price.
US shale operators are loving this news. As I’ve pointed out for months, US shale players want crude oil to hold above US$50 per barrel before producing more wells. That’s happening right now. According to Sputnik News, Frank Verrastro, the Chair for Energy and Geopolitics at Washington, said (emphasis mine):
‘If prices were to stabilize near $50, you would see money going back into the sector and there are three or four thousand drilled, but uncompleted, wells that you can get back online reasonably quickly.’
Baker Hughes, the petroleum engineering firm, said the number of active US oil rigs increased by 11 to 443 last week. That’s the highest level since 5 February when the count stood at 467. It’s the ninth week up in a row. You can see this on the graph below:
Source: Baker Hughes
Click to enlarge
The recent uptick on the graph may not look like much to you. But, it’s a fresh trend worth noting. The rig count has been rising (on and off) for about 21 weeks now.
After peaking at 1,609 in October 2014, the rig count fell sharply with lower crude prices. If crude prices stay at these lofty prices, thanks to OPEC’s manipulation, we may see a huge number of rigs hit the market in the weeks ahead. That would add more supply to an already oversupplied market.
It could be a devastating blow for oil prices heading into early next year.
Focus on the main game
The risk for oil is twofold…
First, OPEC is freezing crude supply at peak levels. When crude demand starts falling during the seasonally lower demand months, OPEC will still be producing oil at near record levels.
Second, the US shale game is a largely overlooked risk. I wouldn’t be surprised, if the rig count exploded higher in the weeks ahead. On its own right, that could add a tremendous amount of production to an already oversupplied crude market.
Adding it up, all signs indicate that crude’s rally is a false move. Prices have rallied to the upside and got everyone bullish, but when this deal crashes and burns, the crude price is likely to plummet.
This isn’t a time to start jumping into the big crude oil stocks. When crude plummets, the best crude stocks are likely to trade at bargain prices. That’s the time to buy.
Resources Analyst, Money Morning
Editor’s note: Greg Canavan has a different outlook on crude oil. He believes that now is a prime time to buy oil shares. Greg recently recommended three little-known Aussie energy plays to take advantage of this development, and all three are already showing gains. You can go here to check out these picks and learn more about his service, Crisis & Opportunity.