Why Crude Oil’s Rally Is a False Move

In today’s Money Morning…signs pointing to a slide in oil…why crude prices are headed to US$40 a barrel…‘psychological warfare’ within OPEC…and more…

Crude oil’s volatile story continues…and all signs point to a major slide.

First, the US shale game is rarely discussed. That’s a mistake. With surging crude prices, the rig count has exploded higher this year. On its own right, that should add a lot of production to an already oversupplied crude market in the months ahead.

Second, OPEC has claimed it will ‘freeze’ crude supplies all year. It’s a manipulative tactic, aimed to artificially drive up crude prices.

Unfortunately, when crude demand starts falling from November to February (the seasonally lower demand months), OPEC will be producing oil at near record levels. That’s assuming it manages to freeze production in the first place. I wouldn’t get your hopes up…

The signs imply that crude’s current rally is a false move. Prices have rallied to the upside and gotten everyone bullish. Yet crude remains significantly below last year’s high of US$62.56 per barrel.

As you may know, OPEC is meeting tomorrow in Vienna to discuss the supply ‘freeze’. I suspect it will be more of a holiday than anything. When the deal falls through — yet again — expect crude prices to plummet back towards US$40 per barrel level.

I’ll explain…

Its smoke and mirrors folks

Despite arguing for massive production freezes, OPEC’s crude output stood at 33.83 million barrels per day (bpd) in October. That’s an all-time record high. You can see the production ramp up on the chart below:

Source: Nomura
Click to enlarge

Keep in mind, OPEC agreed to halt production between 32.5 million to 33.0 million bpd a few months back. It’s also proposing a 600,000 barrel a day output cut by non-OPEC producers.

This ever happening is highly unlikely. Alexander Novak, Russia’s Energy Minister, has repeatedly said that he prefers to freeze rather than cut output. But I don’t believe he will freeze production either.

Yet the mainstream doesn’t see it this way. After all, the entire story sounds great on paper. And investment bank analysts have lapped it up. Business Insider Australia reported on 23 November:

There is a 70% chance that OPEC will agree [to] a production cut of 1 million barrels per day at a November 30 meeting, according to analysts at Nomura. A cut that size would send oil prices up more than $2 a barrel, the Nomura analysts said in a note to clients on Wednesday.

“OPEC has a good track record of taking urgent decisive actions to cut output to boost prices. For example, back in December 2009 following the Lehman Brothers bankruptcy, the cartel succeeded in boosting oil prices from below USD40/bbl to over USD80/bbl within 12 months by cutting 2.5mn bopd from global oil markets,” the analysts said.’

I beg to differ…

Saudi Arabia has now (unsurprisingly) pulled out of the November 30 meeting. According to Iran’s semi-official Mehr news agency, OPEC’s largest producer is ‘reneging on earlier promises’ and waging ‘a full a full-blown psychological war against Iran and a number of other OPEC members.’

If you’re invested in oil, it gets worse…

Saudi Arabia also opted out of yesterday’s meeting with non-OPEC members. The remaining attendees (including OPEC members) called the event off completely. Saudi Arabia claims it wants OPEC members to agree on a deal, before sitting down with non-OPEC producers. And yet Saudi Arabia won’t even attend the meeting with OPEC!

I have no idea how a deal will ever be done. There’s a massive divide between the OPEC nations. Yet, despite the long odds, the oil cartel has managed to successfully talk up the crude price.

Let the chart do the talking

Brent crude, the international benchmark, has surged to US$48 per barrel. That’s 72% higher than the low of US$27.83 per barrel on 20 January. West Texas Intermediate (WTI) is trading at US$46.68 per barrel. It’s up 79% from the low of US$26.05 per barrel on 2 February. As I’ve said for months, don’t discount higher crude prices on further manipulation.

That said, OPEC’s manipulation may prove counter-cyclical. The price surge looks ready to backfire. Remember, there’s more crude oil than ever floating around the world. The entire manipulation scandal has only added to the oversupply issues. That suggests the major low for crude is yet to come.

Take a look at the daily chart below:

Source: tradingview.com; Resource Speculator
Click to enlarge

The chart shows that crude has phased into a downtrend. That’s shown by the blue channel. It appears that the next target is around the US$40 per barrel level. That’s shown by the bottom blue line.

OPEC’s jawboning should keep crude volatile and stuck between this channel during the short term. Only a monthly closing below US$39.23 per barrel would suggest a retest of the major low.

I recommend playing crude carefully. If you’re trading it, I’d look to go short. And don’t forget to use tight stops. If you’re looking to invest, I recommend holding off. This isn’t an investors market…yet.


Jason Stevenson,
Resources Analyst

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