The recent moves in oil might be just the beginning as it would seem oil prices have further room to move higher in the short term.  There is no certainty in the oil markets as a plethora of things can occur.  A better world economic environment can lead to increased or decreased demand.  Changes to well economics can also lead to increased or decrease supply.  Currency valuations can also make barrels of oil either cheaper or more expensive.  The current issue is a sizeable glut in both crude and refined product inventories, which makes any bullish move a difficult one.  Drawdowns in crude inventories have been seen in recent weeks.  The Russians and Saudis have continued to pump.  This has helped to push OPEC production to 33.2 million bpd.  Refining margins have held up, so oil producer customers are willing to buy.  Much of this has been due to a healthy demand from the US, but China is also filling up its SPR.  This has occurred in a very unhealthy world economy.  Europe continues to lag, and Brexit hasn’t helped.  Russia and the Middle East continue to have issues with oil prices at these levels.  There are worries that the recent drawdowns in crude inventories could be short lived.  Nigerian barrels have been pulled from the market after series of terrorist attacks.  Some of this is beginning to come back on line as infrastructure is repaired.  Libyan oil is also starting to increase.  We are seeing oil now loaded on to ships, and production being turned back on.  Iran continues to increase production, and could have another 400K bpd in increases, if it can get to pre-sanction levels.  There is also some dissention out of Iraq, who has also made it clear, it too would like to increase production.  Some believe Chinese demand to wane, as it may already have its SPR full.  There are plenty of reasons to worry going forward, but the short term may look a little better.

We could still see upside going into the OPEC meeting at the end of November.  The US is currently seeing some decent drawdowns in crude inventories, and this week’s result may be more of the same.  Although Hurricane Matthew ended up on the east coast, the storm probably created an issue for shipping lanes.  It may not have been seen as much in the Gulf, but the eastern US refineries undoubtedly saw a decrease in imports.  This could provide a very bullish move in oil prices, while the market digests a possible OPEC accord.  There is no reason to believe that drawdowns won’t continue in the short term, with more worries stretching out to December.  OPEC did a nice job of setting the floor in WTI at $45/bbl.  This in concert with a possible production cut from OPEC and continual decreases in crude could continue the move higher in the price of oil. 

The world oil markets are cloudy at best, but there are a couple of ways to look the data.  The market should be more volatile than normal as there are reasons for a bullish and bearish scenario.  In the short term the focus is on OPEC.  The market has been focused on the surprise announcement it would cut production by an estimated 700,000 bpd.  This announcement was effective based on what appears to be an already balanced market.  Whether this comes to fruition, is unknown.  The market has to wait for an announcement, which should be bullish for oil prices until November 30^th.  Little was expected from this meeting, and why oil prices rallied.  There are several reasons to believe the meeting in Vienna will be a non-event.  History has shown that OPEC lies about production levels.  In the past, members have said it would cut only to watch others do it.  Those still producing are able to steal customers of those cutting honestly.  Any agreement would need to provide checks and balances, so we know barrels were coming off the market.  Everyone should understand there is a possibility these statements were made only to support oil prices.  OPEC understood no agreement would mean oil prices closer to $40/bbl. 

In 2014, crude prices dropped 43%.  This was followed by a 30% drop in 2015.  In 2Q16, oil rallied over 26%.  This run was a little early, but with every recovery there are peaks and valleys.  In 2015, we saw rallies of $42 to $62.50 from March to May.  In August of last year, oil prices dropped below $34 only to rise to $50 in October.  This year we saw lows of just above $26 and highs of a little over $52.  OPEC had believed it could push shale and other high cost oil production off of the market.  Shale has been far more resilient than initial expectations, but deep sea projects have been affected.  Shale needs little capital to get started and production is brought on relatively quickly.  More expensive projects such as deep sea, have been effectively crushed.  This has been devastating for names like Transocean (RIG), Seadrill (SDRL) and Diamond Offshore (DO).  It will take considerable time for this industry to recover, as shale seems to be a safer and more economical way for operators to increase production. 

US production has been resilient.  Although production has declined, many had thought that number would be much greater than expected.  Declines in the Bakken and Eagle Ford have been supported by gains in the Permian.  Gulf production has also been on the rise.  US oil production dropped below 9 million barrels earlier this year.  There are 524 rigs working in the US.  Over the past year there has been a decrease in 271 rigs.  International rigs stand at 934, down 206 yoy.  There are 19 rigs in Colorado, 30 in North Dakota, and 247 in Texas.  The Permian is the home of 203 rigs, with 169 horizontal.  Operators continue to produce more oil with less rigs.  It takes very little time to bring a well on line, and highgrading has increased production per well substantially.  This combined with better well designs have made unconventional production a formidable competitor. 

Saudi Arabia recently tapped international debt markets.  It has been forced to cut pay, welfare and increase energy prices.  Venezuela and other OPEC countries have seen increasing difficulties.  Countries like Iran, Saudi Arabia and Iraq have very low breakeven prices.  Poorer countries are in an increasingly difficult environment, faced with the possibilities of default and even civil war.  Initial moves to solidify an agreement met with failure, as Iran and Libyan chose not to participate.  Both countries do not want to freeze production at historically low levels.  Iraq would also like to continue to increase production through next year, and have been very vocal about wanting to be exempt.  The Saudis initially wanted an agreement of all nations (especially Iran).  This did not occur, and oil prices retreated again.  It would seem that Saudi Arabia will need to act as the swing producer.  If they do not, an agreement may be impossible.  Putin’s comments drove the market higher, after stating Russia would participate in a cut.  The Russians have a lot to gain from an agreement, and continue to try and unify Iran and the Saudis.  This will never occur as the two countries hate each other, and unless one converts to the other’s religious beliefs this will continue.  The Saudis are motivated financially, as it plans the IPO of Aramco.  All of this makes for a difficult agreement, since the producers that need it most are those unwilling to cut.  It sounds like wealthiest producers will participate in the cut, with the bulk shouldered by the Saudis.  It comes at a great time.  Saudi Arabia generally cuts 400K bpd at this time of year anyways.  So it may take very little now that warmest time of the year is passing in the Middle East.

We continue to trade in contango, which means oil prices in the future are greater than it is today.  November of 2016 NYMEX prices are trading at a $4/bbl discount to those in November of 2017.  So one could buy crude now and store it, making an 8.5% annual return.  These situations tend to push oil to storage, and until this reverses to backwardation, we will see oil to continue to be stored. 

Goldman’s  note Tuesday made some bearish statements about the crude markets.  It made some excellent points, but none that will affect the oil markets much before November 30^th.  Goldman believes there is a greater chance that OPEC will reach an agreement to cap production.  It believes that this cut may be done in concert with Russia.  This is motivated by “an elevated funding stress” in Saudi Arabia.  It does not believe the cut will be deep enough.  This reason the cut may be inadequate stems from a good possibility of higher production levels out of Nigeria, Libya and Iraq.  Most importantly, if the cuts are deep enough, it will provide increased prices adding shale barrels.  So OPEC is caught between a rock and hard place.  If it doesn’t cut enough, the market will not balance.  If is cuts too much, US production will come back on line.

The oil markets will continue to see volatility.  In the short term, oil prices could reach a high of $55/bbl with a floor of $45/bbl.  We seem to be entering a period of consolidation that has several factors pushing oil higher.  After the meeting in Vienna, unless a major cut is announced, we expect oil prices to move lower and even possibly test $45.  It is always possible that oil prices could head higher than the range stated, but it would take a relatively large event.  The Middle East continues to be an area economic and religious factors that could create price movement.  Any price movement above $55/bbl will be met with increased rigs in the Permian, STACK/SCOOP, core Eagle Ford and core Bakken.