August 6, 2017
Oil closed Friday at 49.58 , testing the upper level of its wedge pattern. As we noted two weeks ago week, oil was technically oversold so we anticipated a bounce, which did materialize. We see this as simply a bounce off oversold conditions, and do not believe that this was the bottom for oil prices. Watch the wedge pattern, with 50.00 showing as resistance, while 47.00 represents initial support, should this rally continue.
The tug of war between the bulls and the bears continues, with Large Speculators jumping in and buying every dip. Two months ago OPEC announced they would extend their quotas for another nine months, but they did NOT tighten those quotas. As we warned prior to that announcement…
“an announcement of an extension of the quota timeline was already priced in, so unless they tighten those quotas they will not get prices up to the 60.00 range that they want.”
While OPEC and some non-OPEC countries promise to cut production, most non-OPEC countries, with the US leading the way, are ramping up production. The following chart is from the International Energy Agency (IEA) and shows how the US production has climbed to 9.43 mb/d, closing in on the all-time record 9.6 mb/d in June 2016.
We are now nearing the end of the “driving season” where oil stocks decline as refinery utilization rises to peak summer highs, so we expect to see some draw down of inventories. The problem for OPEC is that any increase in demand due to “driving season” is being set by increased production in Libya, Nigeria, Brazil, Canada, & the US.
Note on the following chart that current US inventories are more than 110-150 million barrels higher than the top end of the historic “normal range.”
Not only is the US ramping up production, they are also pouring money back into explorations. There are now 764 rigs operating in the US, up over 128% from the January 2016 low of 334.
There are many supply and demand factors that affect oil prices. Reports on production/supply and demand are reported regularly by the mass media, and it is that reporting that most investors base their decisions as to where the price of oil is headed.
The problem for the mass investors and most hedge funds is that while they must wait for these reports and forecasts to be published, the large producers and merchants have already acted on the data. These large producers and merchants are the source of most of this data, so they know the numbers before they are published.
The reality is that while the mass investors and hedge funds simply do not have the capacity or contacts to access this data in a timely fashion, there is a way we can see what the large producers are doing with the data they have. We can watch what these Commercial Insiders are doing by looking at the Commitment of Trader (COT) data.
On the COT chart below, the Commercial Insiders are the red line, while the Large Speculators are the green line. As we zoom in we can see that the Commercials have been massively selling to the Large Speculators. In fact the Commercial Insiders are currently coming off the most bearish net short position EVER! At the same time the Large Speculators are coming off their most bullish net long position EVER!
The last time we had a spread this wide oil had a severe corrections (red arrows).
With OPEC failing to announce further cuts they have missed their opportunity to reach their goal of lowering oil inventory stocks to their targeted 5-year average and now risk losing even more market share to US shale, and other non-OPEC producers.
The bottom line is there is a glut of supply versus demand. Add in the record levels of speculative extremes, combined with the risk of OPEC members failing to comply with their quotas, the potential for a plunge in prices is much higher than most investors are prepared for.
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