More Support For The Oil Market

Oleh Kombaiev profile picture
Oleh Kombaiev
15.1K Followers

Summary

  • Saudi Arabia once again showed its willingness to support the oil market.
  • Global oil stocks will not change significantly in the coming quarters.
  • In the context of supply and demand balance, the oil market has a fundamental support now.

Instrument

The S&P GSCI Crude Oil Total Return Index (NYSEARCA:OIL-OLD) reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate crude oil futures contract. In other words, the return on the index is directly proportional to the return on the value of the crude oil futures contract. Therefore, the decision to invest in this index should be made after analyzing the oil market.

Analysis

First of all, let's recall what OPEC decided on December 6:

The 7th OPEC and non-OPEC Ministerial Meeting, hereby decided for an additional adjustment of 500 tb/d to the adjustment levels as agreed at the 175th Meeting of the OPEC Conference and 5th OPEC and non-OPEC Ministerial Meeting. These would lead to total adjustments of 1.7 mb/d. In addition, several participating countries, mainly Saudi Arabia, will continue their additional voluntary contributions, leading to adjustments of more than 2.1 mb.

In other words, everything else being equal, the fall in total production volume versus today will be around 0.5 mb/d and OPEC oil production in Q1 2020 will be about 29.2 mb/d:

Based on these calculations and the latest OPEC forecast regarding the structure of global supply and demand in the oil market, we obtain the following structure of the oil market global balance for the next quarters:

In other words, according to OPEC, global oil stocks will not change significantly in the coming quarters. Now, let's estimate what this means for the price of oil.

There are two models that allow us to judge how balanced the price of oil is. It is worth noting that these models quite accurately describe the behavior of the oil price over the past eight years.

According to the first model, the OECD commercial closing stock levels at the end of Q3 2019 correspond to Brent oil prices at the level of $58. That is very close to the current price:

However, the stocks do not reflect the changes in the demand. Therefore, I prefer to use the number of days of forward consumption in OECD (stocks divided by daily oil consumption) as the base oil market balance indicator. In this case, the current balanced Brent price is $68, which is also quite close to the current level:

Bottom Line

  1. Fundamentally, the current price of oil is close to the balanced state. And, thanks to the efforts of OPEC, global oil stocks will not change significantly in the coming quarters. This means that the balanced price will not change either.
  2. Saudi Arabia once again showed its willingness to support the oil market. At my glance, the OPEC deal has a good chance of an extension.
  3. All this indicates that selling OIL is a very risky strategy.

Technically, OIL remains positive and I believe it can reach $12.4 in the horizon of the coming months.

This article was written by

Oleh Kombaiev profile picture
15.1K Followers
Individual investor, data and financial analyst. I am interested in investment decisions based on objective methods of modeling and statistical analysis. Besides, I pay much attention to the psychological aspects of decision making.
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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.

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