USO: OPEC Likely to Keep Tapering Production Cuts

Crude oil recovered from the March 23 low
US output should continue to decline under the Biden administration
US relations with Saudi Arabia and Russia deteriorate
Tapering does not mean lower prices as OPEC+ has control
Higher lows and higher highs on the horizon

The drill-baby-drill and frack-baby-frack days of the Trump administration are fading fast in the crude oil market’s rearview mirror. In March 2020, US daily output reached a record high of 13.1 million barrels per day. Shale crude oil in the US took pricing power away from Saudi Arabia, Russia, and other OPEC members. Over the past years, OPEC+ watched their influence over the world oil price decline.

The US Oil Fund (USO) and the US Brent Oil Fund (BNO) track WTI and Brent crude oil prices, the two world pricing benchmarks. OPEC+’s pricing power is back on the rise, with the US addressing climate change by increasing regulations on extracting hydrocarbons from the earth’s crust. The oil ministers will meet before the summer to decide on the level of production cuts. While they will likely taper production cuts, the cartel’s mission is to achieve the highest possible petroleum price for its members. After years of low prices because of US output, OPEC+ can now make US consumers pay top dollar for oil and oil products over the coming years.

Crude oil recovered from the March 23 low

3 STOCKS TO DOUBLE THIS YEAR

Last week, May NYMEX crude oil futures rolled to June. The June futures price fell from a high of $67.29 on March 8 to a low of $57.29 on March 23. Since then, crude oil has recovered.

Source: CQG

As the chart shows, the June futures recovered to a high of $64.38 on April 20. At the $62.14 level at the end of last week, the energy commodity was above the midpoint of the trading range from the March 23 low to the April 20 high.

Open interest, the total number of open long and short positions in the NYMEX crude oil futures market, was sitting at the 2.331 million level on April 22. The metric has been steady since late March. Price momentum and relative strength indicators were sitting just above neutral readings. Daily historical volatility at the 26.12% level was lower than in late March. After crude oil corrected, the price variance metric reached a high of over 70%.

Crude oil recovered from the March 23 low, and the price action reflects a period of consolidation as of April 22.

US output should continue to decline under the Biden administration

The Energy Information Administration reported that US daily output stood at the 11.0 million barrel per day level as of the week ending on April 16. The production level is 16% lower than the high in March 2020 and is not likely to return to that level under the current administration in Washington, DC.

In a symbolic move on January 20, 2021, President Biden canceled the Keystone XL pipeline project that carries petroleum from the oil sands in Alberta, Canada, to Steele City, Nebraska, and beyond to the NYMEX crude oil delivery point in Cushing, Oklahoma. With Congress’s support, the administration is addressing climate change with stricter regulations on fossil fuel production. The US was the world’s leading crude oil-producing nation over the past few years, but that is changing as environmental regulations will cause output to drop. As the US’s pricing power in the international crude oil market declines, OPEC+’s influence is rising.

US relations with Saudi Arabia and Russia deteriorate

The Biden administration is taking a far different approach than its predecessor to relations with Saudi Arabia and Russia. President Biden’s decision to publish a US intelligence report asserting that the Saudi Crown Prince and heir to the throne Mohammed bin Salman approved an operation to capture or kill Washington Post journalist Jamal Khashoggi is a sign that Washington is recalibrating its relationship with Riyadh. President Biden will only communicate with King Salman, ignoring the Crown Prince, who has been the most potent force in Saudi Arabia and the international oil cartel. US-Saudi relations have deteriorated under the new administration.

When it comes to Russia, President Biden has called President Putin a “killer,” and his administration recently imposed sanctions on the Russians over 2020 election interference, a cyberattack, and other transgressions. The US warned Russia of “consequences” if jailed opposition leader Alexei Navalny dies from his hunger strike. President Putin warned of tough Russian action if the West crosses a “red-line.” Russian and US relations are at a low point.

Tapering does not mean lower prices as OPEC+ has control

Russia and Saudi Arabia control OPEC+, the international oil cartel. As US production falls and demand rises, the cartel is positioned to squeeze US consumers with higher prices. After the price carnage in the crude oil market in early 2020, production cuts stabilized the price. While the cartel has tapered the cuts and will continue to increase its output, higher production will be gradual. OPEC’s mission is to achieve a “steady income to producers and a fair return on capital for those investing in the petroleum industry.” After years of pricing pressures from US shale production, pricing power is now back in the cartel’s hands at a time when US relations with the world’s two leading producers are the worst in years.

OPEC+ will likely balance any future production cut tapering to achieve the highest price possible for crude oil. The crude oil market’s term structure reflects the desire to extract the highest possible price from US consumers.

Source: Barchart

The forward curve shows the backwardation in crude oil’s term structure, where prices for deferred delivery are progressively lower than those for nearby delivery.

Source: CQG

The June 2021 versus June 2022 NYMEX spread was trading at a $4.23 per barrel backwardation at the end of last week. The term structure means that consumers pay the highest possible price. Dominant market participants, including the world’s leading oil-producing countries that are OPEC+ members, can influence the forward curve to maximize revenues.

Higher lows and higher highs on the horizon

We are now at the beginning of the peak driving season in the US. The end of the pandemic will only turbocharge gasoline demand over the coming weeks and months. With US production likely to decline and OPEC+ positioned to influence prices, the prospects for higher crude oil prices are rising.

Moreover, rising inflationary pressures and a weak US dollar over the past year are other supportive factors for crude oil’s price.

The energy commodity has made higher lows and higher highs over the past year, and that trend is likely to continue.

USO shares were trading at $42.27 per share on Monday morning, down $0.19 (-0.45%). Year-to-date, USO has gained 28.05%, versus a 12.17% rise in the benchmark S&P 500 index during the same period.

About the Author: Andrew Hecht

Andy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More...