Oil Shorts Under Attack As Bulls In Panic Mode

|
Includes: OIL, UCO, UGAZ, UNG, USO
by: Gary Bourgeault

Summary

Oil shorts have to cover, but the bulls are the ones that are panicking.

Alleged potential for an OPEC, Russia production agreement main weapon of attack.

Attempts to find any positive oil price catalysts reveal desperation of those increasing positions too soon.

Why many institutional investors misdiagnosed the oil market.

It's becoming obvious and somewhat pathetic in my opinion to see the numerous attempts to prop up the price of oil with stories released from many financial media outlets. The current primary weapon of choice is the alleged openness by Russian and OPEC officials to have a meeting to reach an agreement on production cuts in order to support oil prices.

Why this tactic is being used is there is nothing else believable that would have an impact on oil, as the fundamentals of the market confirm we're in for a long-term, low-price oil environment. Anything dealing with the fundamentals can quickly be shot down if it's an attempt to present a bullish thesis. For that reason, something else has to be tried that doesn't deal with the fundamentals of oil, which in this case is the ongoing reports of a meeting between OPEC and Russia.

As far as it relates to shorts, it does force them to cover, which gives the price of oil a temporary reprieve before the market once again recognizes it as another feint by the industry. After that, once again the shorts re-enter the market, moving in unison with the actual market forces.

It has been working a little longer than usual this time around because the financial media, irresponsibly and dishonestly, continue to report this as an inevitable event, when it's only, in reality, a bunch of press releases designed to create the illusion of uncertainty, which, again, forces shorts to cover their positions.

One of the problems I see with playing this game is after so many false starts, the market will know there is no substance to the rumors, and will increase short positions with a vengeance. The price of oil will also gain momentum on the downside, probably plunging even further than it may have if the market had been left alone by the news outlets.

Also, look who's not talking about an agreement: Saudi Arabia and the U.S. Other than Russia, the rest don't matter.

(click to enlarge) source: pipeline observer Click to enlarge

Latest production cut narrative

The latest in this series of reports are that Venezuela is working with Russia to come to an agreement to cut production. My response is this: who cares? Venezuela has been in trouble for a long time, and is probably in more immediate trouble from the low price of oil than any other producer. Saudi Arabia has been ignoring it, and even though Russia has stronger ties to Venezuela than most OPEC members, it is going to take care of its own interests.

I brought up Venezuela only to show how the media are looking for new ways to spin the same old illusion. The idea is to keep creating the illusion there is progress being made toward a production cut, even when everything is going on as it has been. This temporarily puts a higher bottom on the low end of the price.

This will play out in a negative way for the bulls, as they get hammered once again because they've taken big positions in the oil market far too soon. I'm not talking about market timing here in the usual sense of the phrase, but why the bottom was missed by so wide of a margin as measured by the length of time it'll take for this to work itself out. Also important is the fact this isn't going to work itself out as it has in the past. The oil market may never return to how it operated before.

Investors that missed identifying the bottom - and why

Other than some short-term pain, some investors may think this doesn't make a lot of sense to go to these lengths to support the price of oil. This will be especially true for retail investors who haven't had to experience numerous calls demanding answers to why their positions are getting hammered. I've been a financial adviser and money manager in the past, and believe me, if you miss something in a big way, you spend your time cleaning up the mess.

What I mean in regard to oil is that many institutional investors got it wrong when they took big positions in oil because they thought the market was close to reaching a bottom. Not only has it not reached a bottom, the price of oil will probably be subdued for a long period of time. Don't think these institutional managers aren't being pressured over it. It's probably the reason we continue to see the reports of possible production-cut meeting.

You need to read my articles if you want to get into the details of why they missed, but the major reason is they believed it was another supply cycle that was having an impact on the market, rather than the long-term disruption it is, as a result of the wild success of the U.S. shale industry.

That's important to understand because if it was only a supply cycle, it's simply a matter of time before the market rebalances, usually as a result of OPEC cutting supply. Not only has OPEC not cut supply, but it understands it would make no difference if it did or not. The reason for that is because the oil market has changed over many decades, and what it was a few short years ago no longer exists.

The market missed the bottom because it missed the impetus behind the drop in oil prices. I think there was a stubbornness or refusal to believe this was a disruption rather than a supply cycle. The refusal to admit and embrace what was happening is what has caused the panic among the bulls.

Oil fundamentals are all that matter

Since there are so many attempts to add confusion to the oil market to support oil prices, I keep repeating to investors they need to look primarily at supply and demand as it is, to get an accurate reading on the market.

This is why when media reports emerge about oil, they usually have some connection to supply and demand, otherwise it wouldn't make much sense to the majority of people.

How to analyze the reports is to ask the question as to whether or not this is something happening now, or if it ever does happen, is far off into the future. It's beyond the focus of this article, but capital expenditure on future projects is one example of an item of importance.

As it relates to existing market conditions, you can see why floating the idea of a breakthrough agreement for production cuts is so attractive to media outlets. It isn't based in reality, has little if any backing from the market participants that matter (even Russia's openness is relegated to the private sector, not the government which would make the decision).

Whenever you see assertions that are based on conjecture and rumors, it's safe to ignore them in this oil market. If we were to make decisions on these dubious media stories, we would be continuously paralyzed into inactivity or take positions in oil on a leap of faith rather than on the basis of available data.

How to combat that is to focus on supply and demand in the present, and the inventory reports. No matter what the current media narrative is, usually those factors are all that are needed to give the most accurate measure of the market. Over time, the price of oil will reflect those elements, not the fictitious rumors generated by parties benefiting from their effect on the price of oil.

Conclusion

Just because oil shorts are forced to retreat and cover their positions isn't necessarily a reflection of a reverse in direction in the price movement of oil; it's definitely not the case at this time. All it means is the media rumor mill, in the short term, successfully managed to force them out of their positions and cover themselves - nothing more.

The combination of media reports and the resultant covering of short positions in oil is what has been the source of this so-called oil rally. From there other elements added to build up the idea of an oil rally, but nothing but the reports about OPEC and the Russians being open to meeting together to hammer out a cut in production is the catalyst. Shorts covering their positions appears to lend credence to there being a rally, when in fact they have to do so because of the reports themselves, not any fundamentals related to the oil industry.

Why production cuts wouldn't matter anyway is because if the price of oil did find support, higher-cost producers would boost production, putting a ceiling on the price and putting downward pressure on the price once again. This is the reason investors should ignore the stories and keep their focus on supply, demand and inventory levels. These are what tell the real oil story.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.