Where Oil Prices Will Be by September - and Why the "Distortionists" Won't Be Able to Stop It

Looking back, I had a rather brief childhood. I suppose that results from starting my first college degree (in theoretical physics) at 13.

But I had several loves during that period. One was baseball. In fact, I was rather good until meeting my first genuine slider - a violation of all the rules of nature I was studying at the time.

Another was science fiction and horror flicks.

I probably saw every low-budget release. And there is one thing I remember about a "forward-thinking" vampire (the Christopher Lee type).

They would consistently drain a victim but keep them alive. That would allow for a partial recovery and another meal later.

Much like the current state of the oil market...

So today, let me cut through the noise and tell you exactly why oil prices are yo-yoing and where they'll end up by September.

The Oil "Distortionists" Are at It Again

On several occasions recently, I have written in Oil & Energy Investor about the manipulations being played in oil prices.

Culprits have included big banks, as you'd expect, but also "zombie" funds, among others.

Since July 4, we've been experiencing another example of these manipulations.

The price gyrations in the oil market have brought out the latest bout of doomsayers and speculators.

The doomsayers or "symbol crashers" are into another round of proclaiming an imminent collapse, wildly forecasting prices back in the $30s for WTI (West Texas Intermediate, the benchmark crude rate traded in New York).

Meanwhile, the speculators are tying their wagons to making quick profits from shorting oil, causing a decline in prices beyond any level justified by market conditions.

Keep in mind that these two forces tend to move in tandem, but only in one direction. They must drive the oil price down to make any money.

If the market prompts a jerk upward, these guys must quickly unwind their short positions. That always artificially stokes the upward trend to an overemphasis in the opposite direction.

The equilibrium between supply and demand remains the point most analysts focus upon. But the games being played by the folks I am now calling the "distortionists" make that more difficult.

Let's first set the scene...

Oil Prices Have Been Yo-Yoing - but Not by as Much as It Appears

From June 22 until July 3, an eight-day trading span, WTI prices increased 10.7% ($42.53 to $47.07 a barrel).

Such a spike continuing through a long holiday weekend (there was only abbreviated trading on Monday, July 3) was unusual, but was itself a result of the winding down of a brief weakness in prices over the previous two trading sessions.

Prices would have consolidated in any event after such an increase. And that made a ready environment for another short-fueled downward push.

WTI fell 4.1% on July 5, up 0.9% on July 6, to fall another 2.8% on July 7. A modest rise yesterday followed by what is (as I write this) a flat performance today.

But remember to put all of this in perspective.

In other words, ignore the collective Chicken Littles from the "Sky Is Falling" brokerage firms.

At close of trade Monday, WTI was down 5.7% for the most recent week (i.e., five trading days). At close on July 3, the most recent week had been up 6.4%.

Throughout such volatility, accentuated in no small measure by the yo-yo machinations of traders, there is one all-important focus to keep in clear view. It is a matter I have spoken of often...

It's About the Price Floor, Not the Ceiling

Do not watch the ceiling of prices looking for resistance.

The market in oil actually forms around the pricing floor, and the support level established despite what the distortionists try to do.

A current WTI trading range of between $42 and $48 a barrel has emerged. The unusual spread of over 14% is itself a testament to the rapid movements possible in either direction.

Additionally, while a foray below $42 is possible, there are no market forces to justify remaining there. When it comes to the pricing floor, and with apologies to Gertrude Stein, a tangible "there is there."

As for the ceiling, let's lay out the factors restraining oil prices. There are only two of any consequence (despite what some talking heads on TV want you to believe).

First, concerns remain about that most traditional of all market indicators - supply and demand. This, after all, is the most fundamentally valid issue.

Oil demand has been increasing worldwide. But it consistently collides with a perception of supply. This results in an obfuscation always beneficial to keeping the oil price yo-yo going.

This perception centers on the excess volume that could be brought to market if companies decided to do so. Preeminent here are the known extractable reserves in the United States, along with similar considerations elsewhere in the world.

In other words, there's a fear that something, maybe a virus, will strike and cause American oil companies to dump too much oil into an already saturated market, shooting themselves in the foot.

Well, aside from a few desperate guys who are one step ahead of the sheriff and must sell at any price, this is not happening.

Surplus crude is declining in the U.S. market. And while differences persist in well costs among producing basins, few producers will be looking at ramping up extractions until prices are consistently above $55 a barrel.

Forget all the talk about break-even prices.

Unless a driller is heavily in debt and needs to "pay the piper" by churning a declining revenue stream, companies will leave supply in the ground to await higher prices and then move out production proportionally to market requirements.

The ones who can't afford such a luxury will go belly-up, become acquired by a larger fish, or find their drilling rights relinquished.

As for U.S. rig usage increasing in 22 of the last 24 weeks, the translation into actual drilling is interesting...

New U.S. Drilling Won't Translate into a Production Spike

Most of the DUCs (drilled but uncompleted wells) are still designed to replace existing wells where production has declined and secondary/enhanced recovery techniques are not cost-effective.

This does not translate into a huge spike in new volume.

Yes, it's true that the projections see American production rising to about 10 million barrels a day.

But that will happen in stages and will reflect an overall increase in worldwide demand. Remember, U.S. crude oil exports are now more than 1.1 million barrels a day, and that will be increasing.

As for the global picture, both the International Energy Agency (IEA) and OPEC have extended their outlooks for when balance will be reached, but both still see it coming by the first quarter of next year. Oil prices will reflect that balance in advance of its actually gaining hold in the market.

The second overarching factor is the OPEC-Russia commitment to curb production. Now, Moscow has recently given notice that it may not be prepared to intensify the cuts.

However, Minenergo (the Russian Energy Ministry) has provided ample indication that it remains on board and will consider an additional strengthening of price caps if production outside the present agreement is brought into the fold.

There remains nothing OPEC or Russia can do about U.S. production. Yet there the market conditions I have just briefly summarized will largely do the job.

Libya and Nigeria, on the other hand, are another matter...

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If Global Oil Production Falls, This One Country Will Be the Reason

Neither had been included in the agreement. Saudi Arabia is now pushing to have that changed.

Both countries are members of OPEC and have periodic rises in production that cannot be sustained - whether because of civil unrest in the first instance or expanding infrastructure problems in the second.

That makes their inclusion in the OPEC-Russia deal attainable.

The most likely tempering of overall global production (and, thereby, an allowance for new or over-production elsewhere) is situated squarely in OPEC itself.

Despite having the largest reserves in the world (greater than even the Saudis), Venezuelan production is approaching free fall.

The national oil company PDVSA has been circumspect in its figures.

But even in what it did release, production looks to have declined over 30% from its levels from only a few years ago.

Partly as a result, both PDVSA and the central government in Caracas have acute financial difficulties.

But internal OPEC analysis projects further declines in available exports from Venezuela, with some suggesting levels representing a 50% cut by 2020. That would represent a full 2 million barrels a day (or more) siphoned from the market.

The problems in Venezuela are not going to be reversed any time soon.

An economic contraction (implosion may be a better term) is under way, and it has already unleashed an expanding wave of riots and civil unrest.

Because of all these uncertainties, some have begun to speak about price in excess of $100 a barrel. I think this is wishful thinking.

Yet, as investment banks cut their projections, OPEC is internally increasing its own. The consensus in Vienna (the location of the OPREC Secretariat) is for a price approaching $60 a barrel within 18 months.

In the nearer term, I am revising my estimates, but only slightly...

Oil Is Moving Higher by September

WTI should be $52 to $54 a barrel by September, and Brent (the more widely used global benchmark set daily in London) at around $55 to $57.

This is not an environment where a rising tide lifts all boats.

But there will be some nice plays here with selected stocks that can produce higher-grade oil at lower costs. This remains all about the selection.

P.S. It seems the yo-yoing continues. As I'm finishing this, oil prices are up almost 2% for the day. While there is sure to be volatility both up and down, the trend will be positive.

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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