5 Compelling Reasons To Buy The Oil Dip

|
Includes: BNO, DBO, DBRT, DNO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UBRT, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU, XLE
by: Austrolib

Summary

Oil has risen along with the US dollar since mid April. A dollar reversal will be a wind at oil’s back.

Russia and Saudi Arabia have generated headlines about increasing production by 1 million bbl/d, but these are just headlines.

Russia has only slowly increased production since 2005 and can’t ramp up quickly, and Saudi Arabia is still near max capacity despite recent production cuts.

Venezuelan oil production continues to plummet, and the situation will only worsen there. Iran sanctions have yet to kick in to bring down the country’s oil exports.

Energy stocks are leading oil higher over the last week.

Oil's 10% correction from just under $73/bbl in late May is looking more and more like a gift to oil investors as an opportunity to get in under $70. Oil has been down 9 of the last 12 trading days, and this tends to weaken sentiment and encourage traders to exaggerate bearish arguments and downplay any bullish fundamentals. I don't believe oil can go much lower from here, even if a slingshot recovery isn't imminent. Downside from here looks very limited, and here's why.

First, the dollar index (UUP) has risen 5% since April 17th.

Normally, when a strong trending move like this takes place in the dollar index, oil does the reverse. Not the case this time.

Oil has risen together with the dollar from April 17th until May 22nd, and has basically been steady through the dollar rally (See blue line).

Second, oil has only fallen since then due to indications that Saudi Arabia and Russia were intending to increase production by 1 million barrels a day. I often wonder if people who write these headline stories actually bother to check long-term data. Here is a chart of Saudi Arabia's daily oil production rates going back 10 years:

The most oil Saudi Arabia has ever produced was 10.72 million bbl/d back in November 2016. Current production sits at 9.935 million bbl/d. Going up by 1 million would set production at new all-time records. Even if the Saudis did push production up to daily records, that would still mean there would be no more excess capacity, so no good way to battle price rises should they come in the future.

Third, Russia is only 2.6% away from its own record daily production, and can't really push production significantly higher very quickly. It has taken Russia 13 years to increase production by 1.5 million bbl/d. Does anyone really think they can increase production by a similar magnitude overnight?

I certainly don't. All I see is headlines. The actual production charts tell a different story. Perhaps Trump is "colluding with Russia" (and also Saudi Arabia) again to get the oil price down a bit through news headlines so he can have a better midterm election result. Headlines can only go so far before supply and demand kick in again.

Third, keeping on the theme of supply, Venezeula's oil production keeps declining and it will only get worse. What's going on there is something straight out of an Ayn Rand novel with the government eating all of its infrastructure, willfully destroying its oil industry by seizing assets from private companies which no longer want to work with Venezuelan state oil company PDVSA for very good reason.

Venezuela's oil production is at its lowest since the 1970s, not including the January 2003 general strike.

But it looks like things will worsen from here. ConocoPhillips (COP) has rightfully avenged itself of the nationalization of its oil assets back in 2007 by socialist revolutionary Hugo Chavez, who thought it would be a good idea to just take stuff and hand it out to make it look like poverty was going down, and that this wouldn't have any longer-term consequences. Well, now the chickens are coming home to roost, and ConocoPhillips has seized operations on several Caribbean islands in an effort to collect on the $2B owed to it by Venezuela according to an international tribunal for taking its stuff 11 years ago. This, according to Oilprice and ConocoPhillips' 10-Q, page 15.

ConocoPhillips' actions have resulted in clogged ports off of Venezuela's shores, dilapidated from neglect, so PDVSA can't even load the ships with the oil that it does have. PDVSA is on the verge of declaring force majeure on its contracts, which would plummet the production numbers even further. The socialist government is not loosening its grips on anything, and nothing will improve until it does.

Fourth, we have Iran, whose currency has weakened by 30% against the US dollar in one year, with the EU begging for exemptions from Iran sanctions. It is unlikely that Trump and his extremely hawkish staff will give in on this, especially considering new retaliatory EU tariffs just passed. When the next headline crosses the screen that Trump has denied exemptions, oil could jump again. Yes, if exemptions are granted, oil could step down temporarily, but that doesn't solve the problem of Saudi Arabia and Russia being near max capacity and Venezuela continuing its epic cannibalistic implosion.

With Iran, we have to look at oil exports rather than production. Sanctions are designed to hurt exports rather than production itself.

During the sanction years from 2012 to 2015 until the Obama Administration signed the Iran nuclear deal, oil exports dropped from 2.56 million bbl/d to 1.085 bbl/d. That's a drop of about 1.5 million bbl/d. We can assume that the renewal of sanctions will result in a similar drop, which more than accounts for the 1 million bbl/d that Russia and Saudi Arabia supposedly want to increase production by, maybe. Bring Venezuelan collapse into the equation, and we're still at a supply deficit of 1 million, even assuming that the increase in production actually happens. It will take time for Iran's oil exports to drop, but they will as long as Trump remains president.

Finally, we have a technical signal in energy stocks. Since the end of May, oil has fallen 2%, but energy stocks, measured by the SPDR Energy Select ETF (XLE), have risen 2.6%. Usually, equities lead the underlying asset in either direction, and energy stocks are signaling that the decline in oil is only ephemeral.

Disclosure: I am/we are long CORR, CHK.

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.