Oil: Is OPEC Finally Pushing Price Higher?

by: D. H. Taylor


Recent calendar spread prices have near-front months higher than 6-month contracts.

Hurricane disruptions have added to supply constraints adding to price push.

Back in early June, OPEC was trying their best to push oil prices higher. The market had hoped to cut output from 1.8 million barrels a day to 2.4 million, something I thought was a huge longshot. OPEC did not pull through on that and oil prices dropped. However, now it appears that OPEC members are getting closer to production cuts while simultaneously supply disruptions from Iraq and the United States hurricanes have cut supply. Oil prices are finally reacting to lower supply levels and the price of oil has been heading higher. I expect this trend to continue and I may even need to revise my price targets higher than the $70.00 high levels I stated earlier.

Oil Supply Disruptions

There have been two major supply disruptions in oil lately. The most obvious of these disruptions are the hurricanes that directly hit America's refining region in Texas as well as Florida. The two hurricanes affected both supply and demand. By taking out 20% of the nation's refining capacity - if, but, temporarily - the disruption brought on decreases in supply.

But, when Florida was hit by Hurricane Irma, demand from consumers narrowed. Individuals were not going about their normal day-to-day activities but, instead were busy with cleanup. There was also the fact that in both areas there was some amount of flooding. That flooding took out thousands of automobiles from demand, however, as Monday's Personal Consumption Expenditures data shows, consumers were back purchasing new, or newer vehicles.

Both of these regions are far from recovered. However, tackling supply disruptions has been a major focus for some of the nation's largest oil and gasoline suppliers. Supply of gasoline has been mostly restored back to normal at this point. Still, there is a lot of work to be done before "normal" is achieved.

The other major supply disruption has been Iraq. Although this has not been a major media spotlight item, there has been an effect on oil from this event. The Iraqi army has taken back an oil field and curtailed production by about 120,000 barrels per day. While that is modest, it is starting to add up with oil inventories. This chart shows that inventory growth has spent more time on the negative side than positive over the past year:

OPEC members closer to achieving supply cuts

Back in the summer of 2016, OPEC members had agreed to self-imposed oil cuts of 1.2 million barrels a day, something I was keyed into. After 1 year, they achieved about 85% of that cut. Then, in June of this year, renewing those cuts was back on the table. In fact, some had agreed that they may even cut more.

I thought the potential of more cuts was nonsense.

You have to understand how some of the OPEC members operate. For some of these countries, this is not a business as we know it. Governments own the oil production in certain countries. These governments need revenue. If the price of oil drops what these countries are likely to do is produce more to gain increased revenue; having the effect of a self-defeating feedback loop. The lower price goes, the more these governments produce to grab more revenue. That puts more supply on the table and price invariably drops further.

OPEC only achieved an 85% success of the cuts they were working to accomplish. And, yet, some thought more cuts could happen. I sold into that market heavily and did well; the price of oil dropped about 20% from $52.00 to the recent low of $42.00 per barrel.

However, OPEC has been able to achieve a higher rate of compliance with their self-imposed production cuts; the rate moved from about 85% to 93% of the total daily cuts the organization adding to the supply decreases.

Supply cuts and price shocks

On the one hand, the supply disruptions are a one-time event coming from the hurricane's damage. Eventually, the areas affected by the hurricanes will get back to normal, although I do not see 100% normalcy for a very long time to come.

But, just because any particular company has gotten their supply chains back up and working post-damage, does not necessarily mean that price will snap back to the previous equilibrium price. There is a multitude of factors contributing to current supply.

The OPEC and Iraq cuts are not one-time events. The fact that OPEC is cooperation as well as they are is, well, a bit more surprising than maybe the hurricanes directly hitting the oil industry as they have.

The OPEC cuts are helping significantly as well as the cuts from Iraq. I can see the effects of these lasting for some time. Because of this, I can see the price of oil remaining lofted in the very near future.

Front-month contracts are higher than future contracts

There is a condition in the oil market where a front-month price may be elevated over the future months' prices. This is called "backwardization". When prices for the front month are softer than the back months this condition is referred to as "contango". And, oil has flipped from contango to backwardization for the first time in three years as demand is greater than available supply.

Price Target

At the beginning of this week, I had considered some of the variables to oil and its effects on companies, namely Exxon Mobil (NZSE: XOM). I have gone long oil based upon oil supplies dwindling. I thought that the market could see a move higher up to a range of $55.00 - $65.00. But, I could not see a price rise above the $70.00 level. Now, I am second guessing that initial analysis; I believe oil is on its way to crossing the $70.00 level. But, I also believe that this will add additional time onto my trade.

Now, I am second guessing that initial analysis; I believe oil is on its way to crossing the $70.00 level. But, I also believe that this will add additional time onto my trade.

I am long and have been profitable on my oil trades. I am going to add into this. Also, I am going to take a much closer look at some of the oil companies I trade. I believe there may be higher stock moves than I originally saw possible.

Disclosure: I am/we are long WTIUSD. 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.