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The Great Compromise In Crude Oil

Consumption

Summary

OPEC production declines.

U.S. energy independence is for real.

Producers satisfied with $50.

Consumers satisfied with $50.

A sweet spot for compromise.

Henry Clay was the prominent figure in American history. Aside from running for president unsuccessfully five times, he was a representative and senator from the State of Kentucky and served as the Speaker of the House of Representatives. Clay served as Secretary of State under John Quincy Adams, but his greatest legacy may have been his ability to broker an agreement during the Nullification Crisis when South Carolina declared that Federal tariffs were unconstitutional and therefore null and void within the borders of the sovereign state in the 1830s. Clay also brokered agreements on slavery; he was instrumental in the Missouri Compromise of 1820, the Compromise Tariff of 1830, and the Compromise of 1850 to ease social tensions. Clay was “the great compromiser” who said that “I’d rather be right than be President.”

In an episode of Curb Your Enthusiasm comedian Larry David quoted Clay incorrectly by saying that, “a good compromise is one where both sides are dissatisfied with the result.” Clay may have never uttered those words, but he lived his life and legislated on behalf of the American people in that spirit. When it comes to the $50 price level for crude oil, it is starting to look and feel like a great compromise. After all crude oil at fifty bucks is half the price it was in June 2014 which is a price that makes consumers reasonably happy. At the same time, it is almost double the price it was on February 11, 2016, making it acceptable for the world’s producers. While the price makes neither the producer nor consumer wild with glee, it is a level both can tolerate which amounts to a great compromise.

OPEC production declines

It was the surprise announcement on November 30, 2016 from OPEC that caused the price of crude oil to move back above the $50 level. With the assistance of the Russians, Saudi Arabia, Iran, and other members of the international oil cartel threw in the towel on their strategy of flooding the market with output. The production cut took effect at the start of 2017, and the data shows that most members have lived up to the new quotas over recent months.

The cut was the first in nine years, so the oil market responded by rallying past $50, and the premium for Brent crude over West Texas Intermediate moved higher. While OPEC members and the Russians were slapping each other on the backs, the U.S. shale producers kicked into high gear as the price surpassed the half century mark. Increased U.S. production caused the price to slow its ascent and from December 19 until early March the price of the energy commodity traded in a $4.53 per barrel range on the nearby NYMEX futures contract.

U.S. energy independence is for real

Advances in drilling and fracking technology over recent years put U.S. petroleum producers in a position to respond quickly to the price above the $50 per barrel level. Crude oil inventories and the number of rigs in operation climbed. As of March 31, the number of rigs operating stood at 662,300 higher than the previous year at the end of the first quarter. Each week that the price was north of $50, both the American Petroleum Institute and the Energy Information Administration reported increases in U.S. crude oil inventories. The EIA numbers rose to a record high of 543 million barrels just a few weeks ago. All of the shale oil finally broke the back of the market, and crude oil fell from its trading range on March 8, and the price moved lower to $47.01 per barrel on March 22. Source: CQG

The almost three-month period of price consolidation above the $50 level came to a halt as deferred hedging, and physical selling caused open interest in the futures market to rise to an all-time high and inventories to do the same.

However, over recent weeks, the API and EIA numbers reflected the price fall and production and selling slowed. On Tuesday, April 04 the API reported a withdrawal of 1.83 million barrels from inventories for the previous week. The EIA reported less bullish numbers of April 5 when they said that stocks rose by 1.566 million barrels but the price of oil remained around the $51 per barrel level in the wake of the EIA numbers. The API withdrawal was the second straight week that stockpiles of crude oil in the U.S. fell in a sign that production is now responding to changes in price with lightning speed. The ability to turn on and off the oil spigot in response to price use to be the privilege of only the lowest cost producers like Saudi Arabia and other Middle Eastern nation members of OPEC. However, the U.S. has become a serious player in the world of oil output and now has achieved energy independence as a result of technology.

The balance of power in the oil market has shifted from OPEC to a triad composed of Russia, Saudi Arabia, and the United States. For all three parties, $50 is a price that maintains their dominant position in the market.

Producers satisfied with $50

On February 11, 2016, the price of oil fell to the lowest level since 2003 when nearby NYMEX futures traded at $26.05 per barrel. The price level was a disaster for producers around the world. The Russians found themselves struggling for cash flow. The Saudis cut back on social programs and began borrowing money in the international debt markets. Weaker OPEC member nations found themselves on the brink of economic disaster. U.S. shale production ground to a halt as rig counts plunged as the price fell to a level that was below average production cost. The only winner was China, the monstrous consuming nation that began to build strategic stockpiles of the energy commodity. At $26.05 per barrel, the price was over $80 lower than it was in June 2014. For China, oil was on sale, and it was a case of buy one barrel and get three for free in February 2016.

The rise back to the $50 per barrel level has been a godsend for producers. While they would love to see the price back at $100 per barrel or higher, the events of early 2016 have made them realize that $50 is a number with which they can live and survive. For consumers, $50 is not such a bad deal either.

Consumers satisfied with $50

No matter what the product, a buy one get, three free sale is something that does not go on for very long. I remember going to the supermarket in November 2016 right after the price of lean hog futures plunged to the lowest level since 2002. Every pork product was on sale, buy one get three free, but it did not last very long as the price of hogs rallied from those lows. My pork experience was exactly what the Chinese received as a bonus in oil back in February 2016.

Meanwhile, oil is still cheap for the Chinese and consumers around the world these days when comparing the price to where it was in June 2014 at over $100 per barrel. Consumers would love to see the price back at under $30 but $50 per barrel is a price that they can accept.

A sweet spot for compromise

Henry Clay would have looked at the current situation in the oil market, a price of $50 per barrel, as a great compromise for the producers and consumers of the world. The oil market that used to be under the control of the international oil cartel is now in the hands of a triad composed of Russian-Saudi-American influence with Russia and the U.S. holding the upper hand. The Saudis need to play ball and keep the price stable at $50 if they hope to pull off the biggest IPO in history in 2018 when they sell shares in Aramco to capitalize their sovereign wealth fund.

$50 per barrel amounts to a great compromise for the oil market. I expect that the price will trade either side of that pivot point and remain in the $45 to $55 per barrel range as long as the Middle East remains calm and the global economy continues to grow at a moderate pace.

I want to inform you about an upcoming price increase for The Hecht Commodity Report. On May 1, we are raising our price for the first time. Current subscribers and anyone who signs up before April 30, 2017 will lock in our legacy price. For any new subscriber, I am offering a two-week free trial for the report. The Hecht Commodity Report features a detailed report on the major commodity sectors, covering over 30 individual commodity markets, with analysis on the technical and fundamental state of each market. I also share ways to play those conditions. Sign up for The Hecht Commodity Report and have a look before the price goes up!

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha



13 Comments on "The Great Compromise In Crude Oil"

  1. Plantagenet on Thu, 6th Apr 2017 2:11 pm 

    Since when have markets been about compromise?

    Expecting the price of oil to stay at ca. $50 barrel is absurd— as Heraclitus noted long ago “Everything changes”.

    Cheers!

  2. BobInget on Thu, 6th Apr 2017 3:13 pm 

    Plant, smarter than the average bear.
    There’s no chance of Goldilocks grand kids setting prices.

    Even at $60, Saudi Arabia and other ‘single crop’ provider nations see deficits.
    So called ‘defense’ is mighty expensive.
    Now that US troops join Saudi Proxies duking it out with Iranian and Russian proxies in Syria and Yemen, ‘things’ are about to get really expensive. Conflict zones (over oil) are getting almost too numerous to measure vital US interest.

    In the past few days I’ve attempted to call attention to
    Venezuela. While everyone is holding their breath while our genius President meets to insult China’s President, our neighbors Mexico and Venezuela will no longer be capable of providing crude oil to Americans.
    Will the lack of a million or two BB’s per day stabilize
    oil prices around $50.

    Meanwhile Venezuela, Central Africa, North Korea, Syria, Yemen, S.Sudan crying out for diplomacy, medical and food assistance, not more violence.

    Here’s the biggest problem of all. WHEN oil gets over $100, supply will be little better than today. We’ve blown away too much militarizing the stuff.

    A $50 dollar floor might work if the wold were not at war. If geology, climate cooperated, sadly, that isn’t the case.

  3. rockman on Thu, 6th Apr 2017 7:14 pm 

    Compromise? What a complete lack of understanding the reality of the global oil market. At all times it is an absolute capitulation: refineries don’t come to a compromise with consumers: those buyers independently set the volume of projects they buy and the price they’ll pay. There is no negotiate: in the global free market prices are set by the buyers…not the sellers.

    And since refineries can’t force buyers to pay more then they’ll pay the oil producers can’t force refineries to pay more for oil then they can justify. Granted refinery profit margins will vary as oil prices and consumption evolve. But refineries are not going to pay more for feedstock then they can profit from.

    Rather simple dynamic that appears to mystify some armchair “experts”. LOL.

  4. deadlykillerbeaz on Thu, 6th Apr 2017 9:22 pm 

    Ain’t no compromising oil consumption, it is going to be consumed, it better be there too.

    It is a bargain these days. A gallon of gas can take you a long ways for $2.30.

    Sure would miss it if it were gone, that oil, all of it.

    Won’t be any time soon, so there is really nothing to worry about.

  5. dave thompson on Thu, 6th Apr 2017 10:53 pm 

    “U.S. energy independence is for real” More MSM bullshit.

  6. Anonymouse on Fri, 7th Apr 2017 3:20 am 

    But ricketyman, a day or so ago, you were telling everyone it was CONSUMERS that are utlimately in ‘charge’ of the uS oil cartels decisions, not producers. Now, today, its producers that are in ‘drivers seat’, ahem. Or maybe whoever happens to be in ‘charge’, really depends entirely on whatever rhetorical point your trying to score at any given moment in time.

    Good thing for you though, you have plenty of lube to slide you back and forth between your various canned talking points.

    And Im sure the next time, it will be the ‘consumers’ giving the cartel its marching orders. Or…maybe not, who can say….

  7. rockman on Fri, 7th Apr 2017 11:57 am 

    A – “Now, today, its producers that are in ‘drivers seat'” Your reading comprehension is still shitty. LOL. Perhaps I should have been more verbose:

    “And since refineries can’t force buyers (THE CONSUMERS WHO BUY THE REFINERY PRODUCTS) to pay more then they’ll (THE REFINERIES) pay the oil producers can’t force refineries to pay more for oil then they can justify.”

    So again in a non-monopoly market the consumers of every commodity set the price THE CONSUMERS will pay for that commodity. Of course the Rockman et al would wishes they could force US consumers to buy a lot of gasoline for $5/gallon but the f*cking govt with its damn regulations keeps getting in the way.LOL.

    Yeah, my bad: I expected every reader to have already learned how the basic market forces worked.

  8. Anonymouse on Fri, 7th Apr 2017 4:12 pm 

    Those ‘market force’s you worship are themselves, manipulated and controlled. Known as, market totalitarianism man. Demand, is just as manipulated and managed in a top-down manner, as supply often is. In fact, here in the free-world order it is same groups at the very top, often manipulating both sides of that equation. It helps, at least in part, explain why ‘they’ never seem to lose economic power or standing no matter how badly the broader economy is actually performing (or not).

    Yeah, my bad, I was expecting you might have already learned how the world(or ‘your business’ at least), actually operates, as opposed to the country-bumpkin ‘free-market’ brainwashing all amerikans receive via TV and their dodgy ‘education’ system.

  9. Nony on Sat, 8th Apr 2017 3:04 pm 

    refiners don’t set the crude price or it would be zero. Suppliers don’t either or it would be $200. It is the balance between supply and demand that sets prices. Econ 101.

  10. Davy on Sat, 8th Apr 2017 3:45 pm 

    Econ 101 is for another world not the one we live in. Normal price discovery is nonexistent today in our repressed and micromanaged global System. Artificial liquidity makes oil just another manipulated commodity.

  11. Nony on Sat, 8th Apr 2017 4:00 pm 

    The cartel elevates prices, but other than that it is freel traded. Very liquid (get it, haha).

  12. Boat on Sat, 8th Apr 2017 4:09 pm 

    Rock,

    For years your explainations for oil pricing has been very weird. Check the nony post.

  13. GregT on Sat, 8th Apr 2017 5:02 pm 

    Econ 101 is a failed ideology. Ranking right up at the top with The Tooth Fairy, Santa Claus, and The Easter Bunny.

    Is economics education failing?

    World Economic Forum, Jan 2017

    “The economists are the idiots savants of our time.”

    https://www.weforum.org/agenda/2017/01/is-economics-education-failing

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