Oil: Don't Get Tricked Again

| About: The United (USO)


Oil rose after rumors of a production freeze.

Talks have failed before, there is nothing special about this one.

Venezuela has little bargaining power as its production has been falling anyways.

Domestic outlook remains negative. New rigs are still being added despite low oil prices.

Keep an eye on domestic production and imports tomorrow.

There is renewed hope (or should I say false hope?) for oil bulls. Oil (NYSEARCA:USO) shot up from $41/bbl to more than $43/bbl on the report that countries including Venezuela, Ecuador, and Kuwait wished to initiate another round of talk between major international producers. The meeting has since been confirmed. The likely outcome? Just look at what happened over the past few months. First there was the failure in Doha back in April, then there was the failed talk between OPEC members in June. I fail to see why we should expect anything different this time.

While Kuwait and Venezuela are not small countries in terms of oil production (their combined production accounted for 15% of OPEC's production in June), they cannot succeed without the backing of bigger players such as Iran, Iraq, and Saudi Arabia, who have all been merrily pumping more and more oil. Iran has been particularly aggressive, having increased production from 3.096 MMbbl/day in Q1 to 3.644 MMbbl/day in June. What's funny is that Venezuela is "voluntarily" cutting production anyways (June's production is down 4% m/m), which is likely the result of poor capital spending due to economic turmoil (i.e. no threat of increasing production), so I don't see what value the country can bring to the table.

Domestic Outlook Exceedingly Poor

Last week Baker Hughes reported another week of higher rig count. For the week ended August 5th, oil rigs increased by 7 to 381. Even though I thought that producers would be less inclined to drill, clearly reality reflects the contrary. It's possible that producers are focusing on the most efficient acreage, which would have been the first to benefit from higher oil prices. This means that rigs should ultimately decline as "cheap" areas run dry, assuming oil holds. However, increasing rig counts mean that the short-term outlook is incredibly negative. Keep in mind that the global market is still oversupplied (hence the production freeze talks), so if domestic producers join the fray, a race to the bottom will no doubt be ignited once again (read Oil Could Hit $30).

Last week we also saw Lower 48 holding production constant week over week (the first non-negative week since March) and another surprise oil inventory buildup. Clearly there is nothing inherently bullish about the fundamentals. The gasoline inventory draw was widely cited as a surprise. Perhaps it was a surprise to analysts, but it was most definitely nothing special in the grand scheme of things. Over the past two 52 weeks, a whopping 42% were negative.

What To Look For Tomorrow

Last week's EIA report signaled a possible turning point regarding Lower 48 production, so I believe that domestic production should be everyone's focus. If production indeed increases, then I have very little doubt that we are witnessing a bottom for supply. The new rigs that producers have been putting to work since June may be finally showing some results.

As always, the trend of imports will continue to play a big role. Last week's net imports figure reached a new high since 2015. If imports continue to rise, they will compete with the potential flood of new domestic production, driving prices lower as a result.

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