For the oil bears, the oil environment today resembles that of how the oil bulls felt in January 2015 when oil prices were falling. At the time, Saudi Arabia was firm on its stance to let market forces drive the direction of oil prices, and statements after statements backed Saudi Arabia's drive for market share and market forces.
Well, today is different than January 2015. The oil bulls now have effectively a floor under oil prices, thanks to the Saudis. After drawing down $200 billion in foreign reserves, 30% unemployment in youth population and an economy that's projected to grow at only 1.7%, Saudi Arabia finally realized that the goal of market share was not a reality even for the second largest oil producer in the world.
Saudi Arabia announced today that its production is currently below 10 million b/d. The agreed OPEC deal shows that Saudi Arabia was supposed to produce 10.05 million b/d, but the rhetoric around producing less than 10 million b/d is more to prop up sentiment than actual fundamental changes in the oil market. At the start of the new year, WTI quickly rose above $55 before ending the day $2.5/bbl lower. Ever since the start of 2017, a record net-long position combined with position shifts pushed oil prices below $51 two days ago. Then we began to see comments out of Iraq, UAE, Saudi Arabia and Russia all indicating that they are following the OPEC production cut agreement.
To us, the production cut is important as it will drastically draw down excess storage, but the more important aspect to us is the sentiment change around oil prices. Since Khalid al-Falih took over Saudi Arabia's energy minister position seven months ago, the tone from market share-driven has changed to higher oil prices. Combine this with the 2030 vision and the Saudi Aramco IPO in 2018, and we get a desperate Saudi Arabia that needs higher oil prices. Along those lines, the geopolitical landscape in the Middle East has also drastically changed. Russia, Turkey and Iran have managed to reach a peace agreement in Syria, as Saudi Arabia stops its support for rebel forces in Syria and, in exchange, Russia is agreeing to the non-OPEC production cuts.
There are many pieces to the oil puzzle, but with Saudi Arabia effectively serving as the floor and with the oil markets already in undersupply territory (not even including the production cuts), we see the trajectory of oil prices for the rest of 2017 to be upward sloping. As a result of our geopolitical, economic incentive and fundamental analysis of the oil markets, we believe once storage levels normalize by Q3 2017, WTI should be able to reach $70. (We wrote our detailed outlook to premium subscribers at the start of 2017, and if you are interested you can sign up here.)
Overall, for the oil bears, the Saudi put will make the bear argument increasingly difficult as the market is already in a deficit, any actual production cut only accelerates storage draw. And similar to the oil bulls in January 2015, we all know what happens when we fight against the Saudis.
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.