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posted on 06 December 2016

Oil Deal Won't Last Long

Written by , Clarity Financial

This week, OPEC managed to reach the much-hyped agreement to cut output in a bid to boost oil prices. The ministerial meeting in Vienna is said to have clinched a deal to cut output by 1.2 million barrels per day to 32.5 million barrels per day, the deal comes with a condition that non-OPEC producers also cut production which will be discussed in early December. This is usually where the deal falls apart.

The deal is only for 6-months, and the reality is there is very little expectations that OPEC, or the other producers, will actually comply. Furthermore, the deal will only reduce oil output very modestly and will do little to impact the long-term supply/demand imbalance. Furthermore, any cuts made by OPEC will likely be more than offset by increases in U.S. production which is already on the rise particularly in the Permian Basin.

However, oil traders remain extremely long oil at this point and as such a reversal of oil, once again, back to the low 40’s is very likely.

oil-contracts-wtic-120216

Furthermore, note the very high correlation between the direction of oil contracts and the S&P 500.

oil-contracts-sp500-120216

In 2014, I recommended that all my readers get out of oil-related stocks as the deviation from the underlying commodity price had become too great. As shown, that deviation is back with oil at extreme long-term overbought conditions.

oil-xle-120216

As David Hunt, CEO of the asset management group that manages US$1 trillion in assets told Bloomberg last week, the oil price surge today is “probably not" sustainable.

“For us who are long-term investors, we tend to look at the group of people who are gathering in Vienna and say ‘they’re fighting against history… The cost of producing crude, largely due to fracking technology, has dramatically changed the marginal economics of oil. Fundamentally the economics of oil have changed and we now need to work that through how different industries are pricing, and how commodities are priced on the basis of that."

For those long energy-related equities, this is likely a good time to take in profits and reduce exposure looking to re-enter trading positions on a retracement back to oversold conditions.

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