The Opaque World of Crude Oil

The latest EIA stats painted a seemingly bullish picture for North American crude oil right now.  Crude prices have rebounded from the March re-test of the low, US production seems to finally be falling and Cushing storage levels are starting to draw down.  The story is all good for the North American producer…or is it?

The strong rally in WTI from Mar 17 to May 5 can be largely explained by hedge fund short covering.  In mid March, hedge fund short positions peaked with WTI-linked futures and options amounting to 209 million barrels of oil.  Since that time, hedge fund short positions have declined more than 55% to roughly 93 million barrels.

During this same period of time hedge funds only added 2% to long positions in oil or roughly 7 million barrels.  Not to say that fundamentals don’t play a part in price, but the hedge funds tend to accelerate and/or exacerbate the moves in price in both directions.

There isn’t a material amount of short positions being added to or covered now, nor is there much activity on the long side either, which is one reason WTI has stalled out in the $60 range for the last month.  The hedge funds seem to be moving to the sidelines until they can predict which direction crude will move from here.

Next up, let’s look at the domestic production drop reported in last week’s EIA data. Looking at this data on a weekly basis can be deceptive.  Part of the most recent weekly decline was due to curtailed Alaskan production due to full storage tanks at Valdez (estimated to be ~90,000 b/d) and some of the decline is a function of offshore Gulf Coast maintenance (peaking at roughly ~200,000 b/d).

That would mean Lower 48 production is still as high as ever.

The Gulf Coast maintenance will have a ramp up and ramp down period so it will be difficult to clearly assess its weekly impact, while the Alaska situation is expected to clear itself up for next week’s stats.  It’s plausible that over the next 1-2 weeks we could see US production rise back to peak 2015 levels, which has to be disappointing to oil bulls who were expecting the sharp production declines in light of the dramatic drop in North American rig counts.

Lastly, Cushing storage draws aren’t necessarily bullish right now as they aren’t even drawing down as quickly as last year. This means that on a year over year basis, the storage surplus is still increasing.  Given the fears the market had in March and April of US storage reaching capacity, any storage draw is viewed as bullish in absolute terms…but perhaps we aren’t out of the woods yet.

Of course all this is analysis is predicated on the information available to the EIA.  Along with the EIA and other data resources like OPEC and IEA the unfortunate reality is that all the information that is published today is imperfect at best and in many cases, is simply an educated guess.

National Oil Companies (NOCs) have no need or desire to report any of their activities.  It’s all but guaranteed we aren’t getting accurate information out of Libya, Iraq, Yemen, Iran, etc.  All of the data above would tend to be bearish.

It’s interesting to me that for all the specialized, big name firms who analyze one of the planet’s biggest industries–no one is completely accurate.  It’s not even absolutely necessary to ascertain who is the most correct.  You have to understand who the Market believes is the most accurate—because a shift in direction from the Market leader will likely be the signal as to which direction prices go next.

In the meantime, because of the opacity of information in the crude oil market, the individual investor has to be vigilant about what stocks you own.  The stronger the underlying value of the company, the less it will be hit by a downward move in prices and the more it should benefit from a price upswing.  For energy investors, it means mostly owning the leaders among the producers and other sub-sectors.

But what if you own a stock that benefits from a lower oil price?

Now, the one FACT I see in the oil market is that the US rig count is down some 60%, while oil production is barely off 1%.

At the beginning of 2015, I suggested US oil production would stay stronger for longer than the Market expected.   So far that’s happening—despite a much stronger drop in rig count than anyone thought.

If this trend continues, there’s one stock—A Market Leader—you want to own—CLICK HERE to get my full report.