The Fairy Tale Narrative The Oil Market And Media Want - Investors Beware

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Gary Bourgeault

Summary

Financial media won't allow the fundamentals to drive the oil narrative.

What the new narrative will be in the months ahead.

Where investors have to be especially careful if looking at taking a position in oil.

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source: Stock Photo

One thing confirmed by the recent Doha debacle - where participants in the meeting were allegedly surprised by the inability to reach a oil production freeze deal - was there is a demand for a different oil narrative than the one the reflected by actual market conditions, and it appears the media is going to be sure one emerges that will support the price of oil.

What's troubling to me is the hype surrounding the proposed production freeze which drove up the price of oil in anticipation of the deal, which afterwards, is now being ignored by the market and treated as a non-event. That's a bizarre response from the media and some pundits, who aggressively declared a production freeze as a needed catalyst to support oil.

Now that the hoopla is over, there is already a new story forming that has to be approached cautiously when analyzing individual companies, as it is based partially on actual data, which makes it harder to sift through and find the most accurate information to base our outlook for the price of oil upon.

Recently I wrote on how to view U.S. shale oil producers in the aftermath of the failed freeze agreement. Many of them are risky in this market, and need to be thoroughly investigated in light of a prolonged low-price oil environment. Overall there aren't a lot of companies I feel comfortable with taking a position in, with a few exceptions. We'll look at that a little later in the article.

First let's look at the new spin the media is going to put on the industry.

New oil narrative

As already mentioned, the new narrative being put forward in regard to oil is based in some data from generally trusted sources. The data can differ from organization to organization, but there is a generally consensus being pushed that has been accepted by most investors and analysts.

How it is being reported is there will be an increase in demand for oil in 2016 of about 1.2 million barrels per day. The U.S. oil segment of the market will have production drop by about 1 million barrels per day, with Saudi Arabia offsetting that be exporting approximately 1 million barrels per day extra to the U.S. The final piece of the puzzle is for Iran to add around 600,000 barrels per day to the global market.

It's obvious from these data that it means in the last half of 2016 that would result in a shortage of 600,000 barrels per day. Amazing how quickly this has emerged as the accepted outlook for oil. Based upon this investors are supposedly free to plow their capital into oil companies.

At this time I'm not going to refute those numbers. I only wanted to reveal what is quickly being reported as the results to expect through the remainder of 2016. When most media outlets report on oil, these are going to be the basic assumptions being embraced by reporters and many pundits. Cramer is among many already embracing it as reality.

One obvious question: If this is all so accurate, why was there such push by the media and others to make Doha such an important part of the oil story? The oil sector didn't need the uplift from a production freeze if the market truly believed there would be a rebalancing and more by the end of 2016.

Are the data reliable?

My thought is all the numbers above are very suspect. The major reason is we've never faced this type of oil market when including the variables associated with the U.S. shale industry, and a lot of this is nothing more than educated guesses.

Much of it doesn't include what happens if the price of oil does jump up and shale producers bring hundreds, if not thousands of drilled but uncompleted wells to the market. There are an estimated 5,000 DUC wells waiting on the sidelines for that to happen. This could easily completely distort the production assumptions mentioned above.

Many U.S. shale producers have also become far more efficient per well; lowering costs and increasing production. It's one of the major reasons the industry has surprised competitors, who had been looking for production to be much lower by this time. Little of this is being included in projections.

What I'm saying is agencies like the IEA are using models from the past before shale production disrupted the oil market. There also isn't a lot of adaptation of the numbers based upon the global slowdown, including the major Chinese market.

At this time I think the idea of demand outpacing supply is a very unlikely to scenario. It's even more unlikely it'll be by about 600,000 per day, as it being asserted by a growing number of media outlets and pundits.

The data aren't reliable in my opinion because it's based upon partial information.

Is this a buying opportunity for oil?

Another thing we're starting to hear is the "buy on the dip" mantra, where the idea that anytime a company's price goes down it's a buying opportunity. This is a lazy, sloppy idea in my view, and one that has so many caveats it would take a book to cover them all.

Concerning oil companies, it's more important than ever to consider liquidity and debt during this low-price environment. Companies that have proved themselves over the decades are those that would be the best investments at this time in oil. From that point of view this could be a good time to add to a position, or maybe take a new position. It depends upon how close to retirement and if the investment is for the purpose of building up a dividend portfolio.

Even there is no guarantee the companies offering dividends in the past will be able to retain or grow them. If dividends aren't a surety, it has to be decided whether growth is there to compensate for lower or disappearing dividends. Even if demand were to grow beyond expectations, it wouldn't alleviate much of the pressure from companies with high production costs.

If all an investor is doing is looking at a low point of entry, then there are some opportunities out there. That needs to be tempered with the goals of the investor and the long-term outlook for the company. Investors wanting to take a position in oil would probably do better by spreading the risk in an ETF with heavy oil exposure.

Conclusion

Oil is a very political commodity, and when there is a desired narrative, we can be sure it will be the one most media outlets follow. After Doha, it is clear the narrative is one that will point to the numbers I shared above, for the purpose of giving the impression the rebalancing of the oil sector is upon us.

Taking into account the U.S. shale industry and the lack of visibility on what introducing more oil into the market will bring about, there is no way we can pin down the types of specific production estimates we're starting to hear more and more in the media. I don't believe they can be trusted in any way.

I'm not drawing that conclusion because I believe there's some type of conspiracy out there, but because even organizations like the IEA haven't caught up with the significance of U.S. shale production and its impact on the market. I don't believe we can even know what that will be until we get a couple of more earnings reports to dissect.

Investors with a little play money could take some risks if they choose, but outside of that, I don't see how there can be any confidence in the direction of the market and the price of oil.

My problem with the current demand assumptions is they've been turned into a model that is being considered accurate to work from. I see investors experiencing some pain if decisions are based on these data.

Maybe investing in some of the larger oil companies would be okay, but outside of that, there is still a lot of risk that in my opinion, outweighs the potential reward.

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.