Largely, these are offsetting, at least in terms of immediate sentiment, but there are some things to take away from these and we should make those observations too.
First, the Canadian fires are taking about one million barrels per day out of supply, which is directly influencing the price of WTI. This is supporting prices and is a positive influence on prices, but it is also deemed as a temporary reduction in supply.
However, estimates suggest that the supply could be reduced for months. Many of the oil sand producers will come back online and begin to produce more aggressively again once their employees return, which will only happen after the smoke and the fire dissipate, but even then some supply will be offline for even a little longer. My estimates suggest that out of the one million barrels per day that are currently offline about 700,000 barrels will come back online when employees return to work.
According to Canadian officials, there is no timeline for this, the fire continues to rage out of control, and, as they have said quite frankly, there is no end in sight. My estimate suggests that it could take more than one month for things to get back to normal, and if that's true that one million barrels per day, even if we find that to be reduced in a few weeks, we'll still have a positive influence on the fundamentals for WTI.
That time frame, a few weeks or a month, is an eternity to traders in the oil space. On Thursday and Friday alone, UCO and SCO fluctuated by about 9%, and by that I mean they fluctuated by about 9% on Thursday and then again on Friday. These included premarket trading, but remember oil opens earlier than the stock market so these were normal trading hours for oil. On Monday, we saw something similar where UCO and SCO had a spread of about 7% from the premarket trading session to the time that I was writing this. My point is oil prices move so fast that the duration as long as the one being considered for the Canadian fires is an eternity.
Therefore, although the supply is only expected to be offline for a month or so it creates a balance between supply and demand. Immediately, traders must accept that.
The second of these three influences makes traders nervous. The shakeup in the Saudi Arabian cabinetry, and specifically the oil minister, who was considered to be the maestro of oil prices for the past 30 years, has definitely raise eyebrows, but more importantly it has also set the stage for a reality to set in, and that is the probable decisions Saudi Arabia will make in relation to oil prices going forward.
Specifically, they are much more likely to look to capture market share vs. attempting to control oil prices, and although this was something that was vocalized from the Prince Bin Salmon before, the ousting of the oil minister this past weekend made it more clear to any remaining doubters that Saudi Arabia was unlikely to participate in any attempt to support oil prices but instead much more willing to let oil prices fluctuate on their own, let the market determine where oil prices should be on its own, and focus on market share.
There are vast uncertainties surrounding this. Seasoned oil veterans have appreciated being able to better understand the probability of future oil prices by listening to what Saudi Arabia's oil minister had to say, but that added value no longer exists and as a result many industry professionals have lost one of their primary tools, and that makes them uncomfortable.
In addition, with the reality that Saudi Arabia will not be supporting oil prices, it's also safe to assume that oil prices will likely be more volatile, if you can imagine that. This is, at least, the thinking on the street right now. Without the maestro the orchestra might flounder.
In my opinion, this added uncertainty is completely off setting the fundamental balance from the Canadian fires at this time (for now a least). On one side, we have a fundamental backdrop that supports oil prices immediately and that will likely do so for the next few weeks, which again is a very long time for oil traders, and on the other hand we have a new uncertainty in the market, even though Saudi Arabia have already vocalized its intention.
That brings us to the third item listed at the beginning of this commentary. There are now officially more bullish bets on oil than at any other time in history. Many of those bullish bets come from seasoned industry professionals who appreciated the added confidence, one way or the other, that has been offered by Saudi Arabia's oil minister over the years. Those bullish bets are nervous, at least less certain, and arguably they are the reason oil prices are not higher.
Overnight, oil prices were up by between 1.8 and 2.7% and only after oil started trading in the United States did oil prices reverse and turn negative. This further tells me that the nervousness is not coming from Europe but instead domestically.
Additionally, some investors worry that the changing of the guard in Saudi Arabia might open the door for a drastic decision by Saudi Arabia to do something like add production and increase market share immediately, as a way to make a point and define direction, and there is some merit to that argument, but at the same time Saudi Arabia has benefited significantly by the increase in oil prices and will continue to do so if oil prices continue to increase, so this is a double edged sword.
If they are able to capture additional market share I think they will attempt to do so, but they also may be limited in their scope and when they capture market share it might be at the expense of someone else in the industry, so there is a fine line. Saudi Arabia also will be adding capacity on a seasonal basis to supply the demands that they have within their own country for energy and that may immediately take their ability to add one million barrels per day, as they said they could, out of the discussion.
In summary, had it not been for the shakeup in Saudi Arabia oil prices would likely be substantially higher, much higher than they were in pre-market trading I believe, but the nervousness surrounding the Saudi Arabian oil shakeup is causing some of those bullish investors to step back and rethink their positioning. This is absolutely because they have lost someone they have relied on for years.
I'm not expecting Saudi Arabia to do anything drastic, but instead quietly look to capture market share, and in turn to add production when contracts are established. Although Saudi Arabia did participate in the spot market recently, something that is very unusual for them, I do not believe that will be something they will do regularly. If they capture market share it will be on a contract basis, for the long term, and at the expense of a competitor. I do not believe Saudi Arabia will flood the market with excess oil simply to drive prices down.
In addition, I do not believe that Saudi Arabia, given the additional demand that will begin within the next 30 days, will have the excess capacity to add one million barrels per day to supply anyway. After the demand for additional energy subsides within their country they will have this capacity, but that will not be for months.
In the meantime, if Saudi Arabia doesn't say anything to shake up the market, but maybe simply confirms what Prince Bin Salman has already been saying, and he has been guiding the directive, he was the decision maker n DOHA, and the ousted oil minister was recently acting as a puppet to his directive anyway, so the likelihood that we hear something out of Saudi Arabia that they will stay the course, is high. If they do the tensions that exist immediately from those seasoned investors will likely subside.
That turns its back to the outages and the balance of supply and demand caused by the Canadian fires, and that does not look like it will change for quite awhile. Soon, I hope, they will get the fire under control, but currently there's no end in sight, and the supply disruptions could last far beyond a month if they don't get the fire under control, and that is, according to Canadian officials, a reality. It is not my estimate, but it clearly is a possibility and it emphasizes my point.
Even if the disruptions only last for three or four weeks that is an eternity in the eyes of oil traders and they will not be able to suggest that the fundamentals in oil are imbalanced anymore, at least not over the next few weeks, so the sell side and short side of the market has lost an argument.
Although this weekend's news also brought with it some lost confidence from seasoned investors, given the ousting of Saudi Arabia's oil minister, it is also very clear that the short side of this market does not currently have a fundamental argument.
At some point that will change, at some point that might not even matter given our technical observations, but according to my analysis and might technicals there is a high probability for higher oil prices. This assumes that support levels, which were tested on Monday, remain intact.
Lastly, analysts have suggested that as this year progresses be imbalance between supply and demand will itself correct naturally as demand for oil increases on a global basis, and if that is true, we will learn more about this on Thursday when Opec issues their monthly report, the immediate balance in the fundamentals could carry over and the imbalances that existed with excess supply may not officially resurface. There's a strong possibility that the current supply disruptions in the oil space are followed by fundamental balancing, but that largely and immediately depends on what Saudi Arabia has to say, if anything. They could change my observation completely if they add supply to this market haphazardly. I don't think they will.
Disclaimer: Equity Logic (www.equitylogic.net) Manages an actively Manages Oil-Trading Strategy called LOTS that may hold UCO or SCO at any time without prior notice.