The Saudis made a surprise unilateral cut of 1 mbpd at the OPEC+ meeting on the weekend. The NY Times reported that the Kingdom was forced to make the move as a matter of fiscal necessity:
Saudi Arabia is in “whatever it takes mode,” Helima Croft, head of global commodity strategy at RBC Global Markets, wrote in an investor note this morning. That the country is “willing to shoulder it alone adds to the credibility of the cut and signals real barrels coming off the market.”
Analysts calculate that Brent needs to stay above $80 in order for Saudi Arabia to keep its budget balanced and to finance the ambitious infrastructure program backed by the country’s crown prince, Mohammed bin Salman.
Oil prices initially popped in reaction to the cut, but pulled back over the course of the day.
Here’s what the cut may mean for energy stocks.
A constructive pattern
I noticed the unusual pattern that the energy sector was a leading sector in the China RRG chart on the weekend (see Global market review: Risks and opportunities). As a reminder, the charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom left), which change to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.
I check the U.S. RRG chart and found energy in the bottom left lagging quadrant, but if the counterclockwise rotation pattern holds, it is on the verge of an upgrade into the top left improving quadrant.
The RRG chart for Europe shows that energy is already in the improving quadrant.
An analysis of the U.S. energy ETF (XLE) shows that it is testing a falling trend line. Even though felative breadth (bottom two panels) are negative, they are showing signs of steady improvement.
Here is the higher beta oil services ETF (OIH), which has already rallied through the falling trend line and exhibiting a potential bottoming pattern.
In conclusion, the energy sector has been showing the setup for a buy signal based on improving relative strength and relative breadth. The Saudi output cut may be just be the catalyst for further strength in energy stocks.
The market reaction to the news would be bearish if one goes by the candlestick pattern. Oil futures popped on the open but then traded down from an open above 75 and now we are below 72. This happened recently in April where there was a cut in output, prices popped up and then fell from 83 to 63. Oil seems to be in a downtrend with lower highs and lower lows, if prices were about to pivot a more robust reaction to the Saudi cut should have happened.
Perhaps this is a reflection of decreased global consumption, maybe China is less strong, or maybe Russia is unloading what it can.
Looking at a 2 year chart, we are back to prices pre-Ukraine. So that also is a similar story in that after an initial pop, prices could not stay up. They had been rising up until then, but so had the market. If we are in a bear market and this rally leading up to the debt circus is a bear market rally, then prices will drop as will the price of oil unless geopolitics intervenes (or something else of that nature).
In summary, 3 times the price gets bumped up on supply issues, only to fade. So I think oil goes lower.
The crazy thing is that the greens are making future oil supply likely lower which will cause prices to go much higher, which will make consumption less which will make the greens happy until they see the new prices for all their renewables and batteries etc.
Unless recessions no longer matter because we get helicopter money 2.0 and everything goes crazy including inflation, we should see a new low in the market and in oil, but the market will do as it does.
I have made the point before that oil and gas is the new tobacco. Boards are reluctant to invest in new capacity because it’s a declining industry.
Over the next few years, however, this will create supply shortages.
Yes, and should we get a recession and a got market correction, that could make for a really good entry point to buy energy and hold for a few years. I’m waiting.
Clearly, KSA/MbS is cutting the output because they see weakness in demand. May be more cuts to come. That doesn’t bode well for the prices.
I think the global economy is weakening for now. So, probably we will see lower prices if that is not discounted by the market.
Longer-term, I agree that oil is the new tobacco. It will do very well after some correction over the coming months (if we get one).
A base price around $80 is very profitable for the oil industry.
“Counterclockwise” rotation should read “clockwise” rotation. The error has been corrected.
It’s a byproduct of relying on digital clocks for over a decade.