Oil macro analysis, page-477

Hi guys, I started this thread around 9 months back linking to my oil macro analysis on the oil forum, which I’m linking below again.
http://hotcopper.com.au/threads/oil-macro-analysis-pros-and-cons.2582725/?post_id=15890294

As can be seen there, price of LNG was 2.58 and has taken quite a fall since then. Also as I mentioned there, my thoughts on the oil sector were building up much earlier. Several of my comments on the oil sector have materialized  including broader macro concerns, importance of historical level of 40, broader commodity bust, Chinese and global slowdown, impact of soaring US dollar, geopolitical impacts, falls to 30s and 20s, multiple legs of falls, bloodbaths in the oil sector in December, etc. among many others. I’ve posted a few updates on the LNG and far forums. Posts on LNG forum are below, and only in this thread
http://hotcopper.com.au/search/34722347/?q=%2A&t=post&o=date&c[user][0]=194736&c[tags][0]=LNG+%28ASX%29&c[visible]=1

Special thanks to @FrankMe in particular for keeping this thread active with regular oil macro updates, which I’m sure benefit all, including me. I thought it was time to come up with another update, and I’ll give it my best shot, and will express it as pros and cons as was the case last year (although I seem to have far more cons than pros this year). Warning - This is going to be a very long comment like last year; so grab a coffee if reading it all.

1/ Macro concerns (negative)

I mentioned last year that I have macro concerns and these are still valid. I mentioned last year that I’m bearish on almost anything but gold.
Summary of macro issues
http://hotcopper.com.au/threads/stt-weekend-lounge-17-19-april-2015.2497705/page-66?post_id=15111851

Gold analysis (Long and best read only after reading this entire comment)
http://hotcopper.com.au/threads/gold-%E2%80%93-the-final-bubble.2517192/?post_id=15293903

Property analysis (Long and best read only after reading this entire comment)
http://hotcopper.com.au/threads/are-dark-days-just-starting.2520702/?post_id=15328492

Iron analysis (Long and best read only after reading this entire comment)
http://hotcopper.com.au/threads/fmg-pros-and-cons.2548635/?post_id=15589127
http://hotcopper.com.au/threads/rio-pros-and-cons.2550087/?post_id=15604097

Several of those points are really still applicable, and we witnessed a global rout in stocks in January, due to weak global macro. This risk is ever present for the oil sector and oil IMO is especially sensitive to major chaos as we also witnessed during the GFC. Notice again that January's chaos in global markets was accompanied by chaos in oil.

2/ 40, 50, and 60 levels – Importance of 40 level- 25 year support and resistance and historical level of 40 (key to see in which direction oil now goes)

Here is a 25 year chart of oil, which I also linked last year
http://www.barchart.com/chart.php?s...=0&g=1&p=MN&d=X&qb=1&style=technical&template=

As I mentioned last year, the 40 level is ever so important as support. If we break 40 again, then there is a possibility that it could be a sign of another big fall.

3/ Importance of 50 level (key to see in which direction oil now goes)

http://data.cnbc.com/quotes/@CL.1/tab/2

The 50 level is strong resistance level for oil. Late last year, oil was bumping its head a couple of times around the 50 mark, only to fail to make any significant gain, before finally sinking to new lows towards the end of the year. I had mentioned last August itself in my analysis that oil needs to race away from the 40s to give some confidence. Oil did just that by racing off in some of the best upwards movement over the next couple of days before bumping its head around the 50 mark, which it failed to clear meaningfully.
Oil was recently again moving close to the 50 mark, and IMO, this level is an ever present resistance.
More importantly, it is the level at which shale companies might come back online. I’ll explain it later again in this comment.

4/ Importance of 60-65 level and beyond (Maximum I can see it reaching. Would need strong positive tailwinds for it to continue) –

http://data.cnbc.com/quotes/@CL.1/tab/2
Oil had its first major crash in 2014. As I mentioned in point 3 of my oil macro analysis last year, one of the few things to surprise me was that oil did not test the 40 level in late 2014 despite coming very close but went on to move to around 60. We see that oil was moving to around 60-65 at various points in the first half of 2015, but was bumping its head around this mark.
I’m afraid, I cannot realistically see, oil crossing this mark in quite sometime unless there are some really positive tailwinds. It represents almost a 50% gain from the current mark; so in any case, not many people will be thinking of it too for now; so there’s no need to comment more on this I guess.

5/ Commercial hedgers (smart money) shorts – (possibly negative as short position is still substantial); (key to watch in coming weeks though) -

http://www.finviz.com/futures_charts.ashx?t=CL&p=d1
Large traders have simply been following the trend. They are long close to a a massive 400,000 contracts, while commercial hedgers are short by a corresponding amount. The last time the positions were similar, oil was around 70 (June 2015) and went on to collapse to the 20s by the end of the year. In a final capitulation of oil, large traders would typically follow the trend again and sell massive amounts, exacerbating the fall, which makes me afraid that oil will at some point of time at least retest its old lows if not go much below

5/ Oil rise as part of broader commodity rise  (Negative once it turns)

Important to note that commodities in general rose in the past few months including iron and gold, and oil’s massive rise can be considered a part of a general rise in commodities. If and when this turns, oil will IMO again be hit pretty bad.

6/ Oil rise due to falling DXY (positive in last few months but negative if it changes)-

Oil’s fall last year was to a huge extent due to soaring US dollar index. The US dollar index collapsed quite a bit in past few months which also led to a rise in commodities.
Over the past few days, DXY has been rising again, which promptly led to a fall in commodities like gold, oil, etc. If DXY starts rising again to its levels last year, then a fall in oil is very likely.
http://www.barchart.com/chart.php?s...=0&g=1&p=MO&d=X&qb=1&style=technical&template

7/ Fed monetary policy expectations over last 3 years leading to soaring DXY and corresponding crushing of commodities including oil (to be closely watched going forward)

I elaborated on this point last year too. I mentioned then that I’ve mentioned long ago in my gold analysis (point 3) how the US Fed could go in for tighter monetary policy at some stage but that will cause too much chaos in all markets and the Fed will have to quickly change course and reduce rates again. Note that Fed raised rates in December, and there was huge chaos in global markets as I thought would happen. USD did look like it was strengthening and talks of US recession were starting. Commodities like oil got crushed and gold looked shaky initially when US was just hiking rates.  US quickly changed course and has stopped talk (to a large extent) of rate hikes since past several months as I thought, and forget rate hikes but there is talk of negative interest rates already. All this was putting pressure on DXY over the last couple of months which also led to a huge boost to commodities including oil.

Please note however that they can change course again at anytime, and this should be closely followed IMO, as it will likely have an impact on oil.

8/ Big 4 countries – Saudi, Russia, Iran and US – Iran (negative)

I mentioned in point 13 last year how these are the 4 main countries influencing oil, and having some understanding of geopolitics is crucial for an oil investor. Much of what I thought would happen did happen.
I mentioned how Iran would be negative in terms of new supply but positive from terms of Iran pushing for higher prices. I also mentioned how Saudi – Iran animosity could play a role. That is exactly what has happened and it turns out, that Saudi-Iran were one of the most key factors at the recent Doha meeting. This will continue to be important going forward and like I mentioned last year, Iran is keen to get back the market it lost, while Saudi is upset at that and will hence keep flooding the world with oil.

9/ Saudi (more negative than positive)

I started point 15 last year by mentioning that Saudi Arabia has the power to change the situation any time it wishes, and IMO,Saudi decides how low oil can and should go.
Here are some of the key points I mentioned last year -

a/ Saudi benefits by falling oil prices by thus taking out high cost US shale oil companies from the market.
b/ Saudi benefits by low oil prices as it puts a lot of pressure on both Iran and Russia, with whom it does not get along.
c/ Saudi might also want to send a message to the major powers of the implications of their improving relations with Iran
d/ Lastly, Saudi might want to send a message to the major powers that if they allow Iran to bring more oil to the market, the impact will be much lower prices.
e/ Saudi again wants to defend its share of the market at all costs in a low price environment, using the excuse that if they cut production, then other higher cost producers would flood the market with oil in any case (Similar reasoning used by BHP/RIO for iron).

As can be seen, everything I mentioned in above 5 points for Saudi last year were some of the most important factors influencing oil last year. Needless to say, these factors continue to be extremely important this year too, and I had to literally copy and paste those same words to highlight how important those points are.
I find it hard to believe that Saudi will abandon the oil war so easily now that it has been fighting it for more than a year.

10/ US (very difficult to determine if positive or negative)

I mentioned last year, that US monetary policy is a key determinant in the price of oil, and that factors like US support of the shale sector and US supporting the shale junk bond bubble could be key factors that could lead the US to want higher oil prices. US changed course on its rate hikes talks earlier this year and that led to a rise in commodities including oil, as I discussed above. These factors continue to be important going forward too, and US IMO should be keen to ensure that oil does not go low enough to destroy the shale sector.

11/ Shale re-emergence (extremely negative)

http://www.*.com.au/oil-price-rally-maybe-leading-to-own-destruction-2016-5?r=US&IR=T
This is one of the most critical points to understand.

I’ve linked a nice article above which explains that US shale firms can react quickly to spike in prices, that some shale companies said that they are waiting for the $50 level to get back again, that the recent spike was a lifeline to companies that would have gone bankrupt  and that Russia and Saudi could crank up production if Iran did the same. The article also mentions that we witnessed something similar last year. Oil and shale companies that could have gone bankrupt would now be using hedges to stay afloat, thus inevitably prolonging the oil glut, thus preventing the oil market from realistically rebalancing unless oil has at least one more fall, and a vicious one at that.

Oil needs to have a deep fall for at least some time for the oil market to rebalance, and with spikes like the ones we’ve seen over the last couple of months, this seems impossible. Thus, this key point makes me believe that another deep fall from the current level is almost inevitable for oil at some point of time, as otherwise rising oil prices itself will lead to an oil glut which should then ensure a fall.

12/ Canada fire (temporary event)

Oil recently rose a bit due to the Canadian fires, but this is just a temporary event. I’m just mentioning it here to give some perspective, because there is still a very deep oil glut

13/ New decision makers in Saudi Arabia (negative for oil price)

Very recently, Saudi’s old oil minister who has been there since ages left and was replaced by Falih. The appointment was done by Prince Mohammed, a powerful new player in the Saudi scene, who also influenced the Doha meeting, linking Saudi’s oil decision to Iran’s decision. The message seems to be that Saudi will likely continue on that track. Prince Mohammed has also talked of raising crude output of more than a million barrels  a day if demand exists. As I mentioned earlier, I find it hard to believe that Saudi will abandon the oil war so easily.

http://www.bloomberg.com/news/artic...ys-he-could-add-a-million-barrels-immediately

14/ China stockpiling oil (positive for oil, but could be negative in longer run)

http://oilprice.com/Energy/Crude-Oil/Why-China-Is-Really-Dictating-the-Oil-Supply-Glut.html
Above article mentions that China has stockpiled an impressive 787,000 barrels a day in the first quarter of 2016—the highest stockpiling rate since 2014, that China’s massive buying could put a floor beneath  the current lows, that China could believe that prices are low enough,etc. All these points are very positive for oil and very true in my opinion, too.

I want to add one more point, however, and that point is negative. Several commodities over the last decade shot up dramatically due to demand from China but when the China fuelled demand stopped, the falls were vicious. If Chinese demand stops, the falls can and will be very vicious.

15/ Algo / FOMO / ETF driven buying (positive for now and negative once trend changes)

http://etfdailynews.com/2016/04/28/will-algos-push-oil-back-to-60/
Several oil investors have rushed into oil recently on back of FOMO (fear of missing out). There has also been algo driven buying, ETF buying, etc. as Morgan Stanley’s Adam Longson describes in above article. The question is how sustainable all this buying is, in the face of weakening fundamentals.

16) Short squeeze no more (negative)

At the start of 2016, oil was having a terrible fall and there were talks of oil reaching 10$ and what not. All this led to massive short positions in oil that had to quickly cover as oil started a meteoric rise. Now that short squeeze is over and there are massive longs, which creates a risk, when they eventually begin to sell.

17/ Limited oil storage (negative and extremely negative if storage fills up as it would cause oil price capitulation)

http://oilprice.com/Energy/Energy-General/The-World-Is-Not-Running-Out-Of-Storage-Space-For-Oil.html
I’ve seen conflicting news on oil storage. Above is one where they claim that storage still exists but if there is a place for go, then countries will not yet limit production and hence any oil rebalancing could be drawn out. If however storage fills up completely, then there could be a massive fall in oil.

Here is one article talking of storage near capacity constraints.
http://www.cnbc.com/2016/01/25/crude-storage-at-capacity-goldmans-currie.html
Storage is a key area to watch in future.

18/ Central bank monetizing oil (very positive if it happens)

Central banks across the world have been buying anything and everything including stocks. Could they become buyers of oil too in future, and start monetizing oil. I read an article recently on that but note again that it was just a theory. If such a thing happens, it will be positive for oil. Central banks have moved on to highly experimental and unconventional policies in recent years (including negative interest rates) and even this is not out of the question. Note once again that this is just a theory that I saw being discussed, and there is nothing to suggest that any of this will happen.

19/ Conclusion

As I mentioned last year, Oil like gold is a deeply “political commodity” and can be very tricky to analyse. So making guaranteed predictions for oil is a recipe for sounding very stupid. On my part, I do no such thing but am just sharing thoughts, most of which have been accumulated since my last year’s comment and the few updates since . On my part, I have given some pros and cons and the actual outcome IMO will depend on some or many of these factors. Note that my comments are more applicable over the longer term (over the coming year) than the immediate term, as I expect some of these factors to come into play.

US dollar index (DXY) continues to be one of the critical factors and consequently US monetary policy (possible further quantitative easing, interest rate policies etc). DXY has been rising over the past few days defying the earlier trend. Oil needs to hope for a weak DXY again, like the past few months. If oil has to continue its recent rise, then I'd expect that a weak DXY would be a key determining factor.

The battle of US shale vs Saudi is also a key area to watch, and the re-emergence of shale could be an oil dampener. In response, Saudi could lead to a truly crushing oil glut to destroy weaker players in the shale sector since a prolonged oil war has not benefitted Saudi at all.

The Saudi – Iran conflict again continues to be big, and could lead to a prolonged oil glut, as Saudi seems keen to link its decisions to Iran's decisions, which in turn is keen to recapture its lost markets.

I think oil has good great prospects over time but there could be much more pain before that and a final capitulation of oil needs to happen, and at least a double bottom of the lows of this year, if not lower, at some time in the coming year.

As I mentioned last year, all above is just my best understanding. I am not an oil expert by any means. Many points could be wrong. Also there would probably be more points that I have not yet covered. So please do your own research thoroughly.
Cheers