Oil Fundamental Analysis – Forecast for October 2016

December West Texas Intermediate Crude Oil futures finished September at $48.82, up $2.91 or 6.34%. After posting a two-sided trade most of the month, the market rallied the final week of September, driven by planned OPEC output cuts.

On September 28, in a last minute decision at informal talks in Algiers, OPEC agreed to cut output to 32.5 – 33.0 million barrels per day (bpd) from around 33.5 million bpd.

No other details of the deal have been revealed which likely means they are still being worked out, but should be ready for OPEC’s formal meeting at the end of November.

Although OPEC’s oil deal made the headlines, I think the big story for the month was the five weeks of inventory declines as reported by American Petroleum Institute and the biggest drawdown in crude supplies for a four-week period in three years.

However, this news had very little effect on the upside and prices were falling for most of the month until the OPEC deal was announced. This is because commercial crude inventories in the U.S. totaled 502.7 million barrels, a number that is unusually high for the season.

Gasoline inventories were moving in the opposite direction at the end of the month, rising by 2 million barrels

In other news, the month ended with refineries operating at 90.1 percent of capacity, down on the previous week. They processed an average of 16.3 million barrels every day, producing 9.6 million barrels of gasoline and 4.7 million barrels of distillate.

FORECAST

Despite the strong rebound rally late in the month, traders remain skeptical about whether OPEC will be able to follow-through with its plans to limit output, given a shaky history. Some traders, however, are saving their commentary until they actually read the deal because at the end of the month, details were scarce. This casts further doubt as to whether the cartel and the other large exporting countries can really pull off this new plan.

The bullish traders are saying, however, that the group surprised traders in Algiers and we cannot rule out that they will surprise again. This is especially true because at the end of the month we didn’t know where the hedge funds stood and this is important because they held a large short position into the announcement.

If the hedge funds have yet to aggressively cover their positions then there could be more upside with $53.62 the next potential breakout level on the charts. If the hedge funds decide to defend their positions then we’ll likely see a pullback into support. My point is that I believe we are likely to remain in a range because nothing has really changed. It’s all speculation until OPEC meets in late November and right now the global supply is too high and expected to grow until then.

We’ll probably see more volatility in October, but not much more movement to the upside because I expect U.S. producers to expand output if OPEC is going to cut output and I expect U.S. producers to expand market share.

Further evidence of this can be seen in the Baker Hughes rig count report. On Friday, September 30, it showed the U.S. rig count rose by 7 to total 425, marking the 13^th time in the last 14 weeks the tally ticked up.

Additionally, U.S. producers in the third quarter added 95 oil rigs, the greatest increase in any quarter since 2014. And this occurred when prices were below $50. We’re likely to see this number increase substantially if prices start to straddle the $50 level again and this could reduce the effect of the OPEC output cuts.