As value investors we look at the oil market through a fundamentally data driven analysis. We try and parse the opaque oil data to understand what’s important and what’s noise. What kernel of information, however unclear, could or will impact oil prices. For oil the two greatest risks to our long-thesis has always been the following:
- Macro demand, and
- OPEC / non-OPEC failing to extend production cuts
Today, OPEC/non-OPEC’s decision to extend the production cuts by 9 months removed a large hurdle. The oil market correspondingly sold off as this deal had already been “anticipated”. Nevermind that the anticipation only sprang into existence a few weeks back.
The reason for the sell-off was obvious, there wasn’t a “one more thing”. Now Steve Jobs of Apple (NASDAQ:AAPL) fame was famous for this. Often after his presentations he’d throw in a surprise . . . a one more thing; one more product that could delight his customers. OPEC, unfortunately failed to deliver that. Yet that “thing”, was a figment of elevated expectations. Saudi Arabia and Russia, linchpins to the agreement, had already given the market its “one more thing”, a cut of 9 months instead of 6 months. Sure they did it a few weeks back instead of today. While one could quibble about why they announced it so early and not after the meeting, but the truth is OPEC and non-OPEC are about as good as keeping secrets as our new administration. Thus, why not give the market some gristle to chew on, and why not increase oil prices immediately and put pressure on other participants to agree to the extension. Mission accomplished, and with nothing new to announce, the market backpedaled; risk off for those who were hedging for the “one more thing”.
So here we sit today, with a 9-month cut. Sentiment turned negative and the sell-off was fast and heavy. What we know and what we’re seeing are two completely different things. We know that oil (both crude and overall commercial stocks) have been drawing counter-seasonally. We know that for the past 5 months, OPEC/non-OPEC crude production has actually declined (albeit exports have not), and we know that export levels have been high because OPEC / non-OPEC members have drawn down their inventories.
Bears argue that producer inventories are different than end-consumer inventories, but we’re left wondering, if such inventories aren’t inventories then what are they? We contend that inventories regardless of who holds them are inventories, which means yes Virginia, oil inventories have been declining. Moreover, if production is declining and producers are destocking, then when destocking ends (because your tanks run dry) doesn’t production cuts start to sting?
Silly rabbits are we because it all matters little when oil inventories are high (or higher than necessary). The market surfs on a wave of sentiment and expectations when the oil commodity cup runneth over. This is why we’ve been buying today, because we know, fundamentals steer and sentiment carries. There’s blood and oil in the streets today, but as we head into the summer months the lagging data will become clearer and sentiment will swing momentum in a different direction, and we need to be facing in the right direction when that happens. For now, we think long-term investors should continue to hold their oil investments because the production cuts are working, they will continue to work, and eventually they’ll have worked too well. In the meantime, keep your wits about you and stay the course, and get ready for the turn ahead.
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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.