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Will Saudi’s Cut in Oil Exports in December Fuel Short-Covering Rally?

By:
James Hyerczyk
Updated: Nov 12, 2018, 10:21 UTC

Prices could gap higher early Monday on the news of the Saudi export cuts. Given the severely oversold conditions, the move is likely to be all short-covering. I don’t expect any real buyers to show up because the news isn’t strong enough to reverse the current oversupplied conditions.

Crude Oil

Crude oil bears could be in for a surprise on the opening on Monday due to a shift in the fundamentals on Sunday. According to a report from Bloomberg, “Saudi Arabia signaled it will reduce oil exports by as much as half a million barrels a day in December, the first tangible sign that OPEC is starting to trim output as it faces an oversupplied market in 2019.”

Although the Saudis increased production in November, they plan on trimming shipments for next month, according to Energy Minister Khalid Al-Falih, speaking to reporters in Abu Dhabi.

It’s way too early to talk about a complete turnaround in the market, but the news of a cut in exports should be enough to spook a few of the weaker shorts out of the market.

Grossly Oversold Conditions Revealed in Government Market Data

Hedge fund and money managers have been slashing positions since crude prices topped out during the first week of October. According to the U.S. Commodity Futures Trading Commission (CFTC), hedge fund net-long positions in West Texas Intermediate (WTI) crude oil have declined 18 percent to 160,291 futures and options contracts in the week-ended November 6.

Looking at the situation another way, the net-long position is the lowest since September 2017. Additionally, long investors are now trading at their lowest level since July 2015, while short-seller positions jumped 29 percent to the highest level since October 2017.

This data may be the first sign of an extremely oversold market.

Short-Term Outlook

Prices could gap higher early Monday on the news of the Saudi export cuts. Given the severely oversold conditions, the move is likely to be all short-covering. I don’t expect any real buyers to show up because the news isn’t strong enough to reverse the current oversupplied conditions.

Furthermore, the cut in exports is just a baby step in removing the excess oil from the market. The next step will be for the Saudis to garner enough support from the other OPEC and non-OPEC members especially Russia to make a large enough cut in production to stabilize prices.

At this time, “There is no consensus yet among oil producers about cutting production,” Al-Falih said.

It was “premature to talk about a specific action,” he told reporters, when asked about the possibility of a reduction in output from the entire oil-production bloc. “We have to study all the factors,” Falih said.

If prices don’t gap higher early Monday then this will signal that traders feel the news is not strong enough in substance. Furthermore, it would indicate that traders believe the oversupply could last for months and should have a limited effect on the nearby December and January futures contracts.

Many Obstacles to Overcome

Another reason why any short-covering rally could be short-lived is that the crude oil market has many obstacles to overcome before prices become stable. One such factor is the level of Iranian exports after the United States imposed sanctions on Tehran but granted Iran’s top oil exporters waivers to continue buying oil.

Convincing the Russians to reduce production just after they ramped up output is another issue. Russia was a big help in helping OPEC to rebalance supply and demand in 2017-2018, but they may not be eager to go along with another plan to cut production. Quite frankly, I think they are enjoying the cash flow from their oil business, and would be reluctant to slow down the amount of money coming into the country.

Furthermore, Russian Energy Minister Alexander Novak said on Sunday he wasn’t certain the oversupply situation would extend into 2019. He claims the oversupplied market would continue for the next few months due to seasonal factors, but then by mid-year, the market could be balanced again and demand could even exceed supply.

Bottoming Action?

Typical bottoming action starts with a massive short-covering rally. Then there is a pullback and new buyers step in to build on the first rally. Although I’m looking for a possible gap-opening because of short-covering fueled by weak shorts being spooked by the news, I don’t think the speculative buying that usually follows will be enough to sustain a rally for more than a few days.

Basically the narrative needs to evolve into something more substantive to force the bigger shorts out of the market and to flip the short hedge and commodity fund managers to the long side once again. I don’t think they are going to move from net short to net long because of a 500,000 barrel reduction in Saudi exports.

Technically, WTI and Brent crude oil prices will have to overcome their respective 200-Day Moving Averages before the funds will take any rally seriously.

About the Author

James is a Florida-based technical analyst, market researcher, educator and trader with 35+ years of experience. He is an expert in the area of patterns, price and time analysis as it applies to futures, Forex, and stocks.

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