It’s amazing that less than a year ago, oil actually traded below zero.
Meaning… Someone would pay you to own oil.
A commodity trading below zero was unthinkable at the time. But in the case of oil, it did.
Now, there’s an old adage in commodities: “The cure for low prices is low prices.”
And those low prices forced producers to cut production in 2020. They had no choice. Demand was at a standstill. Oil needed to trade above $45 a barrel for them to breakeven.
Today, oil prices are at $60 per barrel. No longer is anyone willing to pay you to buy oil. But, more importantly, the question is… Where is the oil price going next, and how can investors profit from this move?
I’ll explain shortly, but first…
Far from falling, analysts have recently predicted that the price could rise even further. Some, such as Bank of America, have predicted a rise to $100 a barrel.
But just as low prices cure low prices, high prices cure high prices… They reach a tipping point when producers have an incentive to pump more oil.
That brings us to the biggest player in the oil market, OPEC (Organization of Petroleum Exporting Countries). The OPEC cartel controls more than half of global oil supplies. And below is a chart of OPEC’s production capacity versus actual production.
[Note: Production capacity simply means the number of barrels of oil that it could produce using current infrastructure. It could “flick a switch” in order to increase production without drilling more wells.]
This gives us a big clue about where the oil price could move next.
The green line is showing OPECs production capacity, while the black line is showing the actual amount of oil produced. The difference between the two lines is the spare capacity. This means that the oil market has the potential to produce many more barrels than it’s currently producing. In fact, the difference between capacity and production is only slightly less than the all-time high from June 2020.
So, this situation has to change.
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With oil above $60 a barrel, every company involved in oil exploration and production is in a rush to sell their oil into the market. Why? Because current prices are more than 50% above cost for many shale producers. That’s a lot of incentive in an industry that just recently looked all but done.
They won’t want to take the risk of not increasing production, and selling at a high price. That’s especially so if other producers sell and drive the price lower.
In fact, producers may have already begun plans to increase production during the Texas energy crisis. They understood that weather-related production stops are usually very short term.
So, how will this all play out?
The big event for oil is coming up on March 4. That’s when OPEC will hold a policy meeting with its members. And, as always, the day of the meeting will have major price swings in both directions.
Our guess is that whatever OPEC says at the meeting, production will rise regardless… As the incentive is just too great right now. And, it’s already happening. If OPEC doesn’t increase supply, and prices rise after the meeting, producers will take advantage like they did with the Texas energy crisis. This will ultimately push the price down as supply increases.
And if OPEC decides to start adding supply, oil prices will likely fall 15-20% in a short timeframe.
In other words, based on the current supply and demand picture, it’s really a case of whether the oil price falls in the very short term, or the slightly longer short term.
To play it, investors should behave exactly like producers. If you own ETFs like the United States Oil Fund LP (USO) that have direct exposure to the oil price, we suggest locking in profits.
If you’re a longer-term investor of energy companies – or ETFs like Energy Select Sector (XLE) and S&P Oil & Gas Exploration & Production (XOP) – current shareholders should stay invested… Even with a drop, the oil price will stay comfortably above their breakeven levels.
If you don’t have exposure to this sector, a short-term drop over the next few days and weeks could provide a nice entry point.
Regards,
Eric Shamilov
Contributing Editor, Market Minute
Reader Mailbag
In today’s reader mailbag, Delta Report member Fred shares his thoughts on Jeff’s Friday essay about shorting stocks…
I think your analysis is correct. Short buying could be one answer because the bullish market is about to end.
A $1.9 trillion Covid-19 spending package just passed the U.S. House with only 9% targeting Covid-19. Potential Climate Change Tax, Wealth Tax, and Long-Term Investment Tax increases to ordinary income tax rates – and many other regressive tax ideas – will end the stock market as we know it.
Not to mention the 11 to 29 million undocumented immigrants that will drive wages down and unemployment up… Including a $15 minimum wage that will kill an additional 1.3 million jobs, and numerous other terrible political ideas.
How about no border security, and releasing millions of untested Covid-19 illegals into the general population that will burden and bankrupt the health care system? What about defunding police, and releasing thousands of felony criminals from prison with already skyrocketing crime? What about the destruction of our First and Second Amendment rights?
We all witnessed the election and that could be the norm if that bill passes. If the spending, taxes, and socialist ideas actually happen, it will bring most of our citizens to their knees. Let’s hope it’s not too late…
Except of course for the few elite, you know, the rich kids from the Ivy League schools with their nonsense ideas that have set up a system to rule over us and take power and wealth for themselves.
– Fred
And, Jeff Clark Trader member Allen shares with Jeff his thoughts on shorting stocks…
I saw the email today about shorting stocks. I’m not shorting any, but I sure am selling covered calls at strike prices that I don’t think will come about. If they do, great, I can buy them back at lower prices in the future. That’s just my two cents.
– Allen
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming – and send us any questions – at [email protected].