Oil Is Oversold

Last Friday, oil prices fell for the 10th consecutive day. According to CNBC, this marked the longest losing streak for crude oil in 34 years.

I have covered the factors behind this drop in the previous two articles. To recap, the loss of China as an export market for U.S. oil producers has caused crude inventories in the U.S. to swell, and the Trump Administration’s weakening of imminent sanctions on Iran have both been large factors in the decline.

Matt Badiali, senior research analyst at Banyan Hill, thinks the decline is now overdone. Matt says that from April to September, Iran cut 830,000 bbl/day of exports. But Saudi Arabia and the U.S. expanded production by more than that, so the world didn’t feel the pinch. As Matt explained to me:

My research showed that, during the run-up to Iran sanctions, many of the Asian countries cut back on Iranian oil imports. China included. Those countries cut about 900,000 bbl/day of Iranian exports. That demand didn’t go away, it was filled by the U.S. and Saudi Arabia. Then the U.S. government issued waivers to most of Iran’s oil trading partners. Now that those same countries got waivers, they are buying Iranian crude again…leaving a glut of oil on the market. I agree that the demand hasn’t declined. Supply, particularly from the U.S. is up.

That said, I am very skeptical that the Saudi’s can maintain this level of production. It’s only about 130,000 bbl/day below their highest production in the last decade, and they only maintained that level of output for a few months before cutting back. I believe that the market still has a drop in demand priced in. That seems wrong. I believe this will be the low oil price for the next 12 to 18 months.”

Michael Bertuccio, President & CEO of HB2 Energy, also noted that refinery maintenance may be contributing to the perception of an oversupplied market:

I believe there may be more immediate and shorter-term drivers to oil prices falling – particularly the West Texas Intermediate (WTI) cash market in Cushing, Oklahoma. This is refinery maintenance season. Of the ~14 million barrels per day (MMB/D) of refining capacity in PADD 2 & 3, ~6% has been offline.

It is far more transparent in the physical oil basis markets where we have seen Midland trading $15 plus per barrel under WTI. However, Houston Ship Channel (MEH) is trading closer to Brent, which is currently plus $10/ barrel over WTI. Add a stronger and strengthening U.S. dollar to the equation and I see this as nothing more than a short-term price correction.”

Michael agrees that global demand remains strong—including Chinese demand. He believes exports will accelerate with upcoming pipeline infrastructure and the wide basis spreads will compress towards Brent, which is a better benchmark of global oil values.

One thing is for certain. Oil prices are on sale relative to where they were a month ago. It appears unlikely to me that a continued decline is supported by fundamentals, especially if the U.S. stops granting waivers on Iranian oil imports in six months — as is the stated intent.

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