Rumored Production Cuts Excite Crude Bulls

January 28, 2016 01:09 PM


Crude oil watchers got some fresh news to digest today as Reuters reported Saudi Arabia has suggested a 5% across-the-board production cut for global producers. The move would be most true to form for Saudi Arabia who has been known to combat low oil prices with production cuts, balancing global supplies in favor of producers. Venezuela has been doggedly trying to get OPEC producers to come to the table to discuss cuts, but a meeting ahead of OPEC's scheduled June strategy summit is believed to be unlikely.

cub_sound_lesson02_activity1_header_image_newIt is quite possible that the suggestion of a 5% production cut is little more than crude oil market gamesmanship. The Reuters article is quick to credit Russian sources as saying Saudi sources had suggested the cuts, in a production war game of telephone, evidently. Traders took the bait and WTI prices surged above $33 per barrel in the March contract. Resistance on the daily chart stands around $35.50 which was tested twice in consecutive days on January 7th and 8th. If March WTI can close above $35.55, market bulls will be emboldened. The trouble is, this rally, sharp as it is, is based on news not fundamentals. The realities of weak demand amid burdensome supplies have taken a backseat to trader sentiment.

Farmers are well acquainted with the "you first" mentality. Any farmer with a pulse understands that global and domestic grain stocks are currently a huge weight on price action, but, as with crude oil, rather than slicing production, cutting acres or fallowing row-crop ground, farmers will look to make up for low prices in volume. The realities of growing crops in a low price environment are that if one does not take advantage of every inch of ground, that farmer is leaving money on the table. Crude oil producers have a similar mentality right now... make up for low prices in volume. I do not believe Saudi Arabia is planning any production cuts in the near-term any more than farmers are considering planting significantly fewer acres. And so the global oversupply in both crude and grains will have to run through the system, and producers will have to bide their time until the current commodity surplus flips to a deficit.

WTIJan28I would suggest Russia and Saudi Arabia are merely testing the waters to find out how much strength in crude oil they can churn out from the rumor mill. Given sharp drops in revenues in oil producing nations, we expect the chorus of voices already calling for production cuts to grow and perhaps, one day will be loud enough to spur Saudi Arabia to action. In the meantime, Iraq has decided to increase crude oil production there by roughly 500,000 barrels per day (bpd) to 4 million bpd, and supply additions from Iran are still forthcoming.

Prices below $30 per barrel may not be sustainable, but chances are, a rally based on hollow suggestions of production cuts are even less sustainable. Hot money and attitudes of traders have overrun crude oil market fundamentals. If oil producers do decide to act in concert with a 5% production cut and actually follow-through, the current rumor-based rally would be just a shadow of the upside risk coiled in WTI futures. Actual production cuts would support sharply higher crude oil well into the $40's per barrel and possibly as high as $50. For now, as Saudi Arabia and other OPEC producers troll the markets for rally potential, they seem to have struck a nerve with traders and fund managers with the mere suggestion of production cuts. That being the case, without some similar suggestion followed by measurable action, the potential for a sustained crude rally is not supported by global supply/demand fundamentals.

Click here to read the story from Reuters