This is a sample entry from Craig Turner’s email newsletter, Turner’s Take Daily, published on November 21, 2014.
Last night China’s central bank made its first interest rate cut in over two years while the European Central Bank (ECB) announced it has begun buying asset-backed securities. Both of these actions are not bullish on their respective economies.
The Euro traded to an overnight high of 1.2570 before the news and now it is down almost 2 handles to 1.2388. The US Dollar is higher by 75 cents and even the Japanese Yen has some strength due to the Euro sell off.
The China news caused a rally in Crude but that market has backed off considerably. Crude Spreads have reversed and turned negative on the day.
So why is the Euro having follow through selling but Crude Oil retraces to about where we started?
The Euro has been fundamentally bearish and the news about the ECB buying asset-backed securities is adding fuel to that fire. The Euro is in an established bear market and we had news this morning that confirms the bearish sentiment in Europe. We are short the Dec Euro from 1.2550
While the China news reducing rates can be considered bullish for Crude in a vacuum, there are other factors to consider. Crude Oil is transitioning from a market in tight supply to adequate supply and those fundamentals will win the day until something fundamentally changes. I think it is more important to focus on the next OPEC meeting. When OPEC gets together, they are going to talk about how much crude oil prices have come down, which is their biggest source of income. Crude was at $100 and I bet many of those countries budget their annual expenditures at $90 to $100 a barrel. Now we are at $75 per barrel. That is a serious decrease for income. So what do they do? They have two options:
- Cut production to hopefully increase prices. Volume of barrel sales will decrease but they hope to increase total revenue via higher prices.
- Increase production to hopefully increase more barrel sales. Price of crude decreases but they hope to increase total revenue via higher sales volume.
The cut in production is from the old rules playbook. The problem is the United States has seriously increased its energy production due to the “shale revolution”. As OPEC cuts production, the US is not forced to buy higher priced oil from OPEC. Saudi sales of crude to the US topped out in 2002 at 1.7 million barrels a day. By May of this year it has fallen to 1.1 million barrels a day. I read recently that the latest monthly reports will show the number under 1 million. In the past 12 years the US buys about half the amount of crude from Saudi Arabia than what we used to. Most of that reduction has come since 2008. The chart below is from EIA and it shows Crude Oil Production in the US since 1860. US production was thought to have topped out in 1970 but starting in 2008 that trend has reversed. With new technology, financial incentives to produce more energy, and a US government that will most likely be more energy exploration friendly going forward, I am not surprised at all by analysts who predict US energy independence by 2020. The question becomes, if OPEC cut production, how much of that oil can the US make up in production on its own? The second chart below shows the steady build of US Ending Stock of Crude Oil since 1982. Stocks are up 70% and poised to go higher.
US Field Production of US Crude Oil 1860 to 2014
US Ending Stocks of Crude Oil
The 2nd option for OPEC is to flood the market with oil and materially drive down prices to $65 or lower. At that price point it makes some of the higher cost US crude production fields/operations unprofitable. OPEC gets less money for its product but they are taking market share while deterring competition.
Both scenarios have their issues and I think it will be difficult for everyone in OPEC to come to a consensus. I think in the end OPEC has to realize (if they don’t already) that the writing is on the wall and if the US can become energy independent, many other countries using the same technology and exploration/extraction techniques.
We are bear spread Crude Oil. One reason I like being Bear Spread as opposed to outright short can be seen in the charts below. Look at crude oil spike between 4 AM to 7 AM, which goes from $75.70 to $77.70, up $2.00. We eventually make it back to $75.70 and now we are right around $76.00, so just a little higher from the night time lows.
Now look at the spread chart over the same time. The spread was trading around +$0.15 cents and during the spike the spread actually came in lower to +0.09 and we are not at -$0.05, much lower from the overnight.
Jan Crude Oil 15 Minutes Chart
Jan vs April Crude 15 Minute Chart
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