OPEC’s Crude Refinement

Global Energy

On Friday, another OPEC meeting came and went in Vienna, Austria with abundant anticipation yet, little to alter the current bearish narrative. Contrary to preliminary reports and despite the desperate pleas from member nations Algeria and Venezuela, OPEC remains steadfast and unmovable to its current production levels.

That decision led to a steady futures oil leak on Friday as January WTI futures spilled -$1.11 (-2.70%) to finish the week at $39.97 per barrel – just 37 cents above its year-to-date low made earlier in the trading session.  That spillover has yet to be sopped up as WTI January crude futures begin the new week -3.43% at a new year-to-date low price of $38.60/bbl.

“Broad and volatile” to “dangerously violent” were some of the words aptly describing last week’s commodities trading.  It was actually a two-day period – between Thursday  and Friday - where trading charts were tossed, trading manuals were rendered meaningless, and where fund managers and traders sweated desperately for answers.

It was a 30-hour period where the German Bund erased two months of solid gains by falling -1.5%, one where after a long and measured November gain of 2.58% the Euro Stoxx 50 index cratered -3.61%, one where the U.S. dollar index tumbled by 2.4% - the largest move since early 2009, and one where the WTI January crude oil contract slipped -5.7% in one-hour’s time on Friday December 4th.

On Monday, the trend continues as WTI plunges another 5%, below $39 a barrel, and Brent drops more than 4% to a little more than $41 a barrel. The action weighed heavily on the energy sector, which shed 4.5% and proved to be a drag on Wall Street’s major averages.

Volatile price moves often arouse confusion about both trading and investing.  Information flow arrives at uncoordinated intervals and with various degrees of importunity.  The shear array of data – from the trifling, suggestive, or even considerable – tend to respond significantly at once, while inflation-adjusted or “domino effect” numbers can lag and tell a vastly different story.

As a trader or investor, distinguishing between the temporary and lasting is critical.  Deciphering “facts” – i.e. news and data that we have to reckon with whether we like it or not from “values” – i.e. news and data that we want or like – either because it makes sense or fits within our framework- is all the difference in the world.

Crude is now sticky with boredom

Yet through all the severe volatility and harrowing moves, I would suggest petroleum markets are sticky with boredom as judged by the latest headlines reiterating the tired, retrofitted captions including, “OPEC Members Beg for Production Curbs,” or “Stocks Slip as Oil Prices Fall on Hefty Inventories,” and “Gasoline Falls below $2.00 per Gallon!”

Honestly, after weeks, months, and now years of relatively cheap oil prices one should think the shock value of it all would be well behind us.  By now you’d think we could have drained the swamp from where these headlines were emanating and instead keep our windows open for fresh possibilities.

Years of astonishing headlines combined with years of shocking market moves wear down the most grizzled trading veteran.  It can often lead one to create a subtle but significant shift in investment dogma as the lines become blurry between what we know to be true versus what we believe to be true.

When oil began to collapse in 2014, many were quick to conclude that central bank policies had failed, and that global growth was beginning its death knell.  Not many saw lower oil being the product of many good and great independent inputs coming together in unison.  Less still saw that lower oil would be an economic boon to the consumer and to American ingenuity at large!

Since the mid-1970’s there have been a half-dozen oil declines similar in enormity to what we’ve witnessed this year.

According to recent history, when decreases were the result of increased production, the stock market generally behaved well. When declines coincided with apathetic growth prospects, stocks usually suffered.  In the late 1970’s crude price shift was blown off-course primarily by Iranian supply and then again in the mid 1980’s by Saudi Arabian supply.  The markets were disrupted again in the late 1990’s with the unprecedented Chinese demand story and then during the financial crisis of 2008 when developing market demand screeched to a halt.

At some point the market will come to terms with the reality that this is yet another cycle – one that the markets will eventually digest.

Markets Calibrating to a New Normal

We entered 2014 with supply risk as the over-arching theme as oil traders were panicky over Egypt and its battle for a basic governmental structure, Iran and the prospects of a nuclear resolution, Libya producing through civil war, Saudi Arabia with its aging fields and growing costs, newly minted leadership in Venezuela, and the U.S. will never be able to deliver that much crude to Cushing, Okla.

The demand story was equally compelling and converted many oil bears to bulls as first-quarter reports told tales of uneven yet stabilizing demand support for jet fuel, kerosene and diesel. Demand clearly wasn’t rising; however it appeared to have stopped falling.

Spring turned to summer and traders sifted through recent news of the Arabian Gulf, Ceyhan pipeline, North Sea refinery maintenance, Ukraine, super-congestion in Oklahoma, and violence in Northern Iraq. Market participants pondered possibility, faces pressed up against the confectionary shop window of their monitoring boxes while WTI traded at its yearly apex of $107.00 per barrel. No doubt markets were rattled and looking back, it was extremely difficult to cut through the established petroleum market “doxa” – global supply disruption risk was not just larger than ever, it was broadly diversified amongst a well-diversified spectrum of countries and producers. Prices surely could only go up from here!

Falling oil prices continue to dominate the discussion all the while, traders are dealing with a deck that has been shuffled and recut; coming to terms with a market that is arch, unexpected, with a penchant to be turned with a flick of the wrist. Much concern is paid to the idea that Saudi Arabia is using its low cost production franchise to stifle the U.S. shale industry along with other various and sundry political conspiracies. Perhaps, but imagine the offsetting opportunities of lower prices and the subsequent hastening of downstream technological advances.

It’s quite difficult to make trains of thought run on time however; Americans hold dear a lengthy history of arriving ahead of schedule when properly incentivized. The U.S. petroleum industry will find a way to respond to lower prices with even lower break-even points.