Crude oil (NYSEARCA:USO) dipped ahead of today's EIA release, declining from over $53/bbl to $51/bbl on Wednesday, which was where it traded last week prior to the "bearish" EIA release (read New Normal For Oil).
The downward price movement has largely been attributed to the fear of rising domestic production. This is really old news for me. The threat of rising U.S. production had been on my mind since mid-2016 (read Oil Has Lost Steam), way before the subsequent production rally actually happened. It was one of the biggest reasons why I had been bearish/neutral on oil throughout the second half of 2016.
Just as before, I believe that the market is focusing on the wrong thing this time. I find it ironic that everyone is so concerned about rising domestic production while continuing to downplay OPEC's influence. This is a complete 180 from 2016, when no one cared about rising U.S. production (readers have in fact vehemently denied that it was occurring) and all eyes were on a potential deal regarding a production cut.
In my previous article I explained why I believed that the current trend of rising production will not stifle the positive supply fundamentals of oil. However, it is still important to monitor the situation closely, as the pace of increase in domestic production plays a big role in my argument.
To review, the current production cut agreement calls for a decrease of 1.758 MMbbl/day. At the current domestic production rate of 8.946 MMbbl/day, U.S. producers would have to ramp up production by 20% to negate this sudden drop in supply. Over the past eight weeks, domestic production has only risen by an average of 0.38% per week, hence it is clear that the current pace of increase will not be enough to make up for the missing barrels. Of course, as we can all agree, never say "never" in finance. I concede that if there is a sudden acceleration of domestic supply, then it makes sense for me to revisit my thesis on higher oil. But doing the math, even if domestic production increase by 1.5% weekly over the next eight weeks (i.e. at a rate that is more than triple the recent growth rate), the increase in domestic production (projected to be 10.1 MMbbl/day, for a difference of +1.1 MMbbl/day) would still be lower than the proposed production cut, and we haven't even accounted for the natural increase in demand as the world economy grows.
As for inventory, analysts are expecting a draw of 0.342 MMbbl. After a fairly aggressive build up last week (+4.1 MMbbl actual vs. +1.2 MMbbl estimate), analysts are still forecasting a drop in inventory. While the inventory figure could temporarily move the market, I believe that investors will quickly disregard its importance, as they have done last week. To me, this is a personal victory as I've long advocated that investors should place minimal emphasis on this slippery figure. For this report I would continue to focus on the rate of domestic production, which I project to be 8.99 MMbbl/day, representing a growth of 0.5% over last week.
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