Pullback In Oil Prices Provides An Opportunity

The amazing compliance from OPEC members and Russia to production guidelines has drained the surplus from global supplies and brought oil prices up to trade in the mid-$60’s here in the U.S., and the mid-$70’s everywhere else. But, the recent announcement from the Saudis and Russia promising a production increase of up to 1 million barrels per day to limits that have been in place since December of 2016 has the oil markets taking a breath from their upwards march. For now, the signals of more supply are weighing on the oil price, with the meeting still almost two weeks away.

The fascinating dynamic between the three most important players here – the US, Russia and the Saudis – is going to tell the real story of what the final outcome from the OPEC meeting will be and where oil prices are going to go from here.

Let’s analyze the motivations of all three and make a plan:

In the U.S., Trump has tweeted his unhappiness with higher oil prices, and there have been indications that he’s gotten some concessions from OPEC to increase production and keep gas prices at a manageable level through the midterm elections.

On the other side of the globe, it’s clear that Russia has benefited enormously from higher oil prices – but their loyalty to OPEC and the global supply chain is historically weak – if there is a commitment for another 1m barrels a day to be added to the production pot, Russia is going to lobby for a lot of that allocation for itself.

Last, we have the Saudis, who at the very least need to look like they are helping President Trump towards stable gas prices. After all, the Saudis were virulently opposed to the Iranian Nuclear deal and the U.S. President did deliver on his promise to abandon it and reinstate sanctions. However, and this is a big caveat, the Saudis still must make their IPO of Saudi Aramco hugely successful if young prince Muhammad bin Salman is to survive, and for that, they’ll need an even higher price for oil – optimally over $100 a barrel.

So, what do I think will happen? The tightrope that the Saudis need to walk is the key here – delivering the impression of keeping oil prices lower, yet still obtaining at least 100% compliance on the original production deal through 2018. By doing that, they are assured that global stockpiles will still continue to drain, if more slowly than they have for the past several months. Bin Salman and al-Naimi have shown a brilliant ability to walk these tightropes in the past year and a half, and I expect them to successfully navigate it this time.

So, one should expect oil prices to remain moderated up to the meeting date of June 22nd, and with that, oil stocks to remain moderately priced as well. It is possible the many will perceive the pressures of Russia and the U.S. to be too much for the Saudis, predict the meeting will be a disaster and therefore sending oil stocks significantly lower immediately prior to it.

I see this as an opportunity.

Continued bottlenecks in the Permian shale play will finally cap oil increases there, and with continued 100% compliance assured by crafty Saudi moves, the oil price will again resume its steady creep higher – in spite of President Trump’s angry tweets.

For us, there remains the same strategy that we’ve been following, only now it should become more aggressive: To accumulate cash by jettisoning under-performing Permian shale producers and centering back into those more mature EFS and Bakken E+P’s that are less than 50% hedged into the coming year. Those names include Continental Resources (CLR) and Marathon (MRO).