Three Keys to a Bottom in Oil

Three Keys to an Oil Bottom

Oil is up more than 20% from last week’s lows, and the “this is the bottom” crowd is growing larger.

We have harped on the fact that a bottom in oil is key to a rally in stocks, so we want to clearly spell out what events could occur to make us declare a bottom is in (none of these have happened, so we view this recent move as a counter-trend rally in a downward trending market).

First, US production needs to drop considerably and consistently. Long time readers know that this global oil surplus is largely due to additional US production that has come online in the last few years.  So, until US output declines materially, supply/demand will remain skewed. Despite a plunge in rig count, US oil production has remained surprisingly resilient to the oil price decline so far (partially thanks to hedging strategies), but that can’t last forever, and sooner or later operations are going to be shut and US production will begin to fall.

US Oil Production is not declining near enough to support prices.  It must decline substantially from here for a real bottom to develop in oil.

In the latest EIA forecast (January 12, 2016) they are expecting total US crude output to fall from 9.2M b/d in Dec ’15 to 8.5M b/d by Nov ’16. Obviously that is 700K b/d. And although that will still likely leave a modest global production surplus, the market wants to see a move towards equilibrium.

Over the next 10 months we will need to see weekly production declines average upwards of 15K b/d in order for the production aspect of the fundamental situation to shift from bearish to just neutral. Right now, that’s not yet happening as oil production has actually increased over the past few months, but going forward, weekly declines of more than 15K b/d could start to be considered bullish.

Second, OPEC cuts production. This is obviously especially important today.  First, as a rule of thumb, any OPEC headline is not important unless it includes Saudi Arabia for the simple reason that all other OPEC members cheat on their quota and pump full out. Saudi Arabia is OPEC, and so far the Saudis continue to pump oil in an effort to put high-cost US producers out of business.

That hasn’t happened yet (much to their surprise, I’m sure) and fiscal pressures are building on the Saudis, so the chances are rising Saudi Arabia cuts production, but that remains a big “if.”  Hopes of Saudi production cuts have been around since this market broke nearly two years ago. However, if Saudi Arabia does cut (and more if it cuts in cooperation with Russia) that will be a big step towards oil prices bottoming.

OPEC Production remains near multi-year highs, and until this production starts to actually decline, oil prices will remain under pressure.

With regard to today’s headline, the Saudis have denied it, but as we said this is almost certainly not going to be the last rumor of this type and going forward our paid subscribers trust us to look past the headlines and tell them:

  • If these production cuts are real,
  • Implications for oil and US stock prices, and
  • What to buy if oil really has hit a bottom.

Third, Iran doesn’t produce. The removal of sanctions and the expected increase of 500k bpd of production from Iran has been a bearish influence on oil since the earliest mention of the idea. At this point, the market has priced in Iranian production increasing by 500k bpd sometime in mid-2016 but any shortfall or delay on that number will be positive for oil prices.

Specifically, if Iran can’t meet what the market has priced in because they are either 1) Trying to support price or 2) Don’t have the infrastructure, that would be a bullish influence on oil. 

Bottom Line

Absent one of these three things occurring, we will be very skeptical that oil has bottomed, even in the face of an impressive oversold bounce.

And, our paid subscribers know we will be watching oil for them, every single day, because getting the bottom in oil “right” will be the key to outperforming this market in Q1, and we are dedicated to making sure we do that for our subscribers.

A bottom in oil is the key to a rally in US stocks, and if all we do is help you recognize the bottom in oil before your competition, this report will more than pay for itself.

Leave a Reply