Oil prices up despite lack of production freeze

Crude oil prices are rallying despite the fact that storage tanks around the world are filled to the brim with unsold oil. The oil markets remain over supplied, between 1 and 2 million barrels of crude are being pumped out of the ground every day in excess of demand. You would think that the failure of the world’s largest oil exporters to reach an agreement in Doha on Sunday to freeze output to January levels, would cause a selloff in crude.

Cushioning the blow from the failure to reach a deal was a short strike by oil workers in Kuwait to protest cuts to benefits and wages. There has been a significant amount of disrupted oil that came off the market in the last month from Colombia, Iraq and Nigeria. Iran’s ability to increase production quickly is also being questioned. Plus U.S. oil production has fallen below 9 million barrels a day for the first time since Oct. 2014 which is attracting some fast money into oil market.

One of the biggest factors effecting the price of oil is a weaker U.S. dollar which has fallen around 5% over the past seven weeks. The Fed’s dovish comments on future rate hikes has helped increased the price of all commodities. Plus there is a rumor that Saudi Arabia and Russia have agreed to freeze production. (Saudi Arabia pumped 10.2 million barrels per day for a third straight month)

“While this recent rally has the potential to run further to the upside … we believe that it is not yet driven by a sustainable shift in fundamentals,” Goldman Sachs said in a note to clients. Goldman said it was “premature to embrace these green shoots”, maintaining its view that a sustainable balancing of the market, driven by declines in U.S. shale oil production, would take place in the third quarter of 2016. “

Oil analysts and market watchers have noted that Saudi Arabia’s strategy has appeared to pay off, with data showing that shale oil producers are closing down rigs every week and oil output is dropping. Major oil companies trying to preserve their cash flows are still cutting their capital spending budgets ensuring that new oil production will be years away. Although Saudi’s strategy has damaged the government revenues, it has enabled the so-called cartel to retain its market share of just under 40 percent.

Could Saudi boost output?

I believe that relations between Saudi Arabia and Iran hit another low following the failure of the Doha talks, there are reports now that Saudi Arabia, Iran and non-OPEC producer Russia could all be ready to ramp up production, rather than restrict it.

Mohammed Bin Salman told Bloomberg that the kingdom could increase output by around 10 percent a day if it wanted to, saying “If there is anyone that decides to raise their production, then we will not reject any opportunity that knocks on our door.”

Could Mohammed Bin Salman’s aim be to discourage oil companies from investing in new output in Iran? It sounds like a threat to me that Saudi Arabia may indeed decide to boost output to protect its market share and cause the supply/demand imbalance to continue.

There are a lot of moving parts in the oil market. The fast money traders are betting that the U.S production of crude oil will continue to decrease and the summer driving season will push up demand. Even without a production freeze, many believe that the supply / demand imbalance will correct itself sometime in 2016.  Just remember that markets are forward-looking!

Earnings releases in the oil patch next week.

• Mon – Halliburton, Pioneer
• Tues – BP
• Wed – Total, Baker Hughes
• Thurs – Conoco Phillips
• Fri – Exxon, Chevron, Phillips 66

It is impossible to predict how bad investors will punish companies that don’t beat the lower earnings estimates. It could offer a good buying opportunity.