OPEC: Fearing An Oil Glut?

Something's not right in the oil market.

Oil prices crept higher overnight. But a confusing picture is emerging from OPEC's most recent remarks, as the cartel announced that it is taking its formal production boost off the table, even as it announces that it will increase shipments to certain customers.

The Wall Street Journal and Dow Jones Newswires, deep inside an overnight article, quoted traders as saying that there is a decreasing number of buyers for OPEC oil, and that OPEC isn't really trying to sell its oil very aggressively at the current time.

According to the report "Traders at refiners holding Saudi supply contracts said Aramco had offered their companies extra supplies for May lifting but wasn't making the hard sell it did at the end of last year, when it put heavy pressure on refiners to take more crude. ["This time, Aramco was not forcing the extra crude on us,"] a trader with a big U.S. refiner. ["They said there was more around if we needed it and did not mention it more than once."]"

On the other hand, Russian oil production rose, according to the latest figures. According to a Stratfor.com situation report: "Russia's oil production rose 3.6 percent, reaching 114 million tons in the first quarter of 2005, the federal state statistics agency reported April 18. Production increased 10.5 percent in March 2005 from February 2005."

At the same time, OPEC is taking a production increase resolution off the table, but will increase the amount of oil it is releasing in May by 500,000 barrels as it prepares for what it expects will be increased demand in the fall.

Much of the cartel's sudden lack of enthusiasm for full bore production may have to do with the price of oil starting to fall. But, underlying the change of heart could be the thought that maybe an oil glut is on the way, at least in the short term.

Indeed, the situation is increasingly interesting. According to the Wall Street Journal, OPEC is suddenly very patient. "Almost immediately after approving a 500,000 barrel a day hike in the ceiling in March, the Organization of Petroleum Exporting Countries began talking about another one." But, "OPEC President Ahmad Fahad al-Ahmad al-Sabah put those talks on hold Monday. Oil prices have fallen to levels that are ["almost fair,"] so the group can wait until it meets on June 15 to decide on a ceiling hike, he said. The about-face shows OPEC has grown less enthusiastic about pumping more oil and that, even with prices about $50 a barrel in New York, is now more concerned about the downside. It's also an acknowledgment that, even if the group wanted to produce more oil, it would have trouble finding buyers."

According to the Journal, Saudi Aramco, the state owned oil company will only boost May oil shipments to Asia, while keeping shipments to the U.S. and Europe "steady."

It is an increasingly important scenario, and one that the markets may not have come to full grips with just yet, "with oil company inventories of crude rising steadily, especially in the U.S., few buyers are clamoring for more oil. Already, there are signs Saudi Arabia isn't boosting supplies as much as the market had originally anticipated."

Mixed Messages Suggest Confusion

OPEC is ambivalent about what its next step should be. On the one hand, it wants to keep its customers happy, given the fact that there is competition, among the members of the cartel, but also from Russia, whose production is creeping higher, despite forecasts that it would be slowing.

The big uncertainty comes from two factors: 1) the overall global economy, and its status. And 2) more important is what happens in China over the next few weeks to months.

A major decline in China's economy would send oil prices falling in a hurry.

It is that uncertainty that is making OPEC a bipolar institution these days? If it cuts back production it could send oil prices so high that the global economy falls into a recession, and oil prices could plunge.

But, if it produces all that it can, the cartel could create a glut. And if there is a glut, and at the same time there are no buyers, as the Journal reported, oil prices can't stay up above $50 forever.

In the oil market, supply rules. If there is so much oil floating around now, that refiners are not interested in buying any more, and the Saudis are not pushing oil as they did a few months ago, it sounds to us, as if supply is at levels that are more likely to trigger falling prices.

If you read between the lines, in the Journal's report, OPEC may be trying to talk oil prices down to a soft landing, instead of the alternative, a very nasty crash and burn.

Which is why Wednesday's supply data from the API and EIA is likely to be a significant set of numbers.

Oil Market Summary And Outlook: $50 Holds

The collapse in oil below $50 did not come. Instead, early Monday breaches below the key support level stabilized. By overnight trading and early Tuesday, oil had bounced and was testing the $51 area.

Oil and oil service stocks clearly predicted the top in oil as far back as early March, when the oil (XOI) and oil service (OSX) indexes failed to confirm the new highs in the futures prices. But, they managed to bounce back on Monday.

There is still a whole lot to be resolved. There has been a lot of hype lately, and the global economy is in flux.

Oil prices are mostly influenced by supply, which has improved significantly in the last few weeks. Supply data out on Wednesday will again affect the market.

It's also important to remember the hype that surrounded the Goldman Sachs analysis, released a couple of weeks ago that was calling for oil prices at $105. On April 1, in this space, we voiced our doubts about the Goldman Sachs report: "What makes the analysis somewhat questionable, in our opinion, is that the oil markets move more on supply than demand. Second, the global economy is starting to slow. With OPEC still pumping full tilt, if the global economy slows, then demand will likely slow. To us it sounds as if the potential for an oil glut, not a catastrophic shortage is at least as likely a scenario. To be sure, there is still plenty of demand, especially in China and India. There is also a bottleneck in U.S. refinery capacity. And yes, the world is different after 9/11. But, you'd think that at $55 plus dollars per barrel, the market would have priced in a whole lot of stuff, already. In fact, there are some things in the timing and content of the announcement that have a bit of a nasty ocean breeze smell to them. According to Reuters: ["Goldman Sachs is the biggest trader of energy derivatives, and its Goldman Sachs Commodities Index is a widely-watched barometer of energy and commodities prices."]

At this point, the decline in oil remains in the correction class, given the scope of the bull market that we've been in. Until the 200 day moving averages on futures contracts get taken out convincingly, we remain in a long term up trend in oil, and in our opinion, we are not very likely to see oil below $40 per barrel for some time, unless something very dramatic happens, such as a collapse of the Chinese economy, which as we've stated numerous times (see our archived IQ reports) is a plausible scenario.

Investors should remain wary of the oil market, and should use extreme caution in any exposure there. Aggressive traders should be short at this point.

The Philadelphia Oil Service Index (OSX) loks ready to bounce. But there is plenty of overhead resistance. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) is in deep technical trouble in the short term, unless it can quickly turn around. The index could be headed for the 750 area in a hurry.

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