What's An Oil Investor To Do? Conflicting Data Clouding The Near Future - Or Is It?

| About: The United (USO)
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Summary

The one area OPEC remains an influential player in - it has nothing to do with production.

Speculators have a decision to make at the end of October.

Is there a conspiracy against the market price of oil? - Changes in how U.S. crude oil lease stocks are measured suggest yes, there is.

The cat-and-mouse game surrounding oil supply and demand and how it could be frustrated by economic forces.

Source: Stock Photo

It has been instructive and interesting to watch the rhetoric released by OPEC and Saudi Arabia in regard to the proposed production cut allegedly coming at the end of November.

What's important about it isn't whether or not OPEC remains the swing producer in the oil market, because it has lost that position to the U.S. shale industry a while back. What's important is how the old school analysts and pundits treat the cartel as if it's still in the swing producer role, or at least riding the assumption from the market that it is.

This is why important data coming out from the oil sector that points to rising production in the U.S. in particular, is largely shrugged off by the market, as the verbal intervention of OPEC is overriding the fundamentals.

This is really the one key thing to understand and acknowledge - whether many of us like it or not - and that is the fact OPEC can still intervene in the market from a public relations point of view and prop up the price of oil temporarily, even if it no longer has the teeth it did in the past to back it up.

Even now many OPEC members are producing at or near record levels, and those that have had internal strife are starting to bring back production to the market. That means Saudi Arabia will have to take on the bulk of any production cut in order to comply with the assertions made by OPEC.

To show the weakness of OPEC's role, all it has been able to do is push up the price of oil to $50 - a level that only makes it easier for the top U.S. shale companies to make a profit as they transition to higher-producing and more efficient wells.

The declining OPEC factor

Investors need to ask themselves why after about two years of "allowing" the market to take its course in regard to oil supply and Saudi Arabian officials in particular have numerous times stated they didn't know what to do about the emergence of the U.S. shale industry, they now have seemingly found a new way to support the price of oil without shrinking their own market share.

The answer, of course, is they haven't. Sure, we can speculate concerning the level of the proposed production cut and draw the conclusion OPEC is only going to cut to a level where shale oil producers won't be able to come back in force and frustrate the strategy. We could, but I don't. OPEC no longer has that ability.

Now it does have the influence to do that in the short term, but that's not based on its production levels, but on the public relations side of the equation which financial media is glad to embrace and report on to attract more viewers. That, in turn, creates a temporary self-fulfilling prophecy of higher oil prices. The problem is rhetoric, even successful rhetoric, has to eventually be backed up by real data and facts to endure long term. I don't see that with OPEC, and that's why over time, this is going to fail to achieve the desired results.

This is why even though the oil rig and well count in the U.S. has been climbing week after week, it has done little to impact the price of oil. Not only that, the wells being brought into production are more productive than in the past, which will bring more supply than anticipated to the market.

Also a factor is an alleged decline in stockpiles in the U.S., which has created the illusion of falling supply because of increased demand. Part of that is from the decision by the EIA to change the way it measures "crude oil lease stocks in the U.S.," which artificially drives down inventory, even though oil is still available.

Inventory storage measurement changes

I find it more than interesting concerning the closeness of the announcement by the U.S. Department of Energy to call for U.S. inventory levels to be slashed by at least 100 million barrels, EIA's decision to change the way it measures "crude oil lease stocks in the U.S.," and the call by OPEC to lower its production levels. That combination has had an enormous impact on the price of oil, even though the market has already dropped the change in inventory policy of the U.S. down the memory hole.

As far as the fundamentals of oil are concerned, inventory levels have been one of the most important elements in the price of oil, along with the growing rig count of U.S. shale producers. Anything that can change the perception of oil stockpiles in the U.S. can change the outlook speculators, in particular, have concerning the oil market. If oil stockpiles are declining, then it must be because demand is starting to outpace supply. Under a market not getting interfered by governments, that would be true, but that's no longer the case in the U.S., and it never has been with OPEC countries, even with the decision by OPEC to let the "market" decide the outcome of the price of oil.

The reason OPEC decided that was because it had no choice, as U.S. production disrupted the oil market in the past, present and for decades to come. It has no power to change that reality, and so it continues on with its PR campaign in relationship to cutting production. On the U.S. side, the major interference is coming in the form of how crude oil lease stocks in the U.S. are being measured.

What needs to be considered first is the U.S. Department of Energy called for crude inventory levels to be slashed from about 700 million barrels of oil to a range of 530 million to 600 million barrels of oil. That in and of itself points to government interference in the market because supply and demand are the only factors that determine inventory levels, if the government is kept out of the market. Calling for a specific stockpile level means there is going to be something done to achieve the goal outside of market forces alone. That has already started to happen.

How it's being done is the EIA has been told to change the way it measures oil by excluding over 30 million barrels that aren't stored in official storage farms. Only when it's transported to these farms will it then be counted. So while the oil is there in storage, it won't be considered as existing until it is moved to approved storage facilities recognized by the government.

I believe this is one of the reasons we're seeing a steady decline in oil inventory in the U.S.

Supply and demand still the game

All of the things being talked about here can only have a temporary effect on the price of oil, and it's a move to support oil at about $50 in order to give demand a chance to catch up with supply.

The problem is the global economy isn't cooperating with the elites trying to control the price of oil, and it's backfiring on them as the pace of demand slows down and the next recession is getting closer to being a reality. At that time demand will fall even more and the increase in supply will put more downward pressure on oil.

If anyone thinks at that time Saudi Arabia is going to continue to take one for the oil team, they're mistaken. I'm not convinced it's really going to participate in a big production cut in November because it is really not taking as big of a hit as it appears it will. The reason is it always cuts back production as the cooler weather in the region arrives, and that may give the market the appearance of a bigger production cut than is actually being employed. That includes other oil producers in the region which may be included in the cut, when in fact it's nothing more than seasonal adjustments combined to meet the agreed upon output cuts.

All of this is being done to buy time, as already mentioned, and that's really the global game being played now. The market in no way supports oil at $50. It would be in the low $40s at this time without the PR nonsense of OPEC. If this strategy fails, which it's going to, it will punish oil in a big way because the market, in general, will start to understand it's been played.

It will fail because it's being attempted as the pace of demand for oil starts to collapse. That is only going to get worse as the global economy continues to slow down.

Conclusion

What has caused confusion in the oil sector is the contradiction between the fundamentals of the market and the irresponsible attempt at intervention by OPEC, to give the illusion it still has the underlying foundation to back up its marketing hoopla by controlling the flow of oil. Those days are long over.

Those that misunderstand the disruption as a result of the growing U.S. shale industry have noted that OPEC can change the amount of oil on the market if it chooses to. That's true. What isn't being considered is it has never done this since shale producers have disrupted the market, and OPEC has not suddenly decided to cede market share to U.S. producers in order to be perceived as the good guys in the industry.

The competition in the oil industry has soared, and that has brought a lot more oil to the market than can be consumed. That will continue on as shale producers come roaring back to the market.

Again, all OPEC and disingenuous attempts by the U.S. government to give the appearance U.S. oil stockpiles are plummeting can do is try to buy time in order to support the price of oil. This is only effective at this time because of the transition by shale producers as they increase production levels. That window is real, and it will last a little while longer, but once it starts to close, it's going to close fast.

As mentioned earlier, with all this interference, all that oil has been able to do is climb to about $50 per barrel. Everyone is out of ammunition now, and while there will probably be one more big upward move in the price of oil as the end of November nears, afterwards we're likely to see a vicious downturn as the details of the production, which will be seen as little more than seasonal adjustments by a handful of countries in Africa and the Middle East.

Finally, there is also the upcoming decision by speculators of managed money concerning whether or not to roll their long positions into the expanding contango at the end of October, or wait to see how OPEC plays its hand in the latter part of November. I tend to think they'll take the safer position because of the uncertainties surrounding the OPEC decision and the impact it'll have on the price of oil.

Unless OPEC surprises with a production cut deeper than it has announced, there's really not much more to price into oil other than a confirmation that the cut will take place.

For that reason, I'm thinking there will be a decision by most speculators to play it safe and ride it out until there is further clarity. Again, most of the money to be made on the verbal intervention has already been made. Now we're back to fundamentals and how long it takes for the market to organically rebalance supply and demand.

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.