More Grist for the Mill...
March 15, 1999
Crude Awakening?
The oil rally looks like a selling opportunity
By Cheryl Strauss Einhorn
A selling opportunity. That's what the recent 30% runup in crude-oil prices may present traders. Major petroleum-producing countries surprised observers Friday by agreeing to curb output by 2.7%, or two million barrels a day, which was as much as four times more than some forecasters had expected. But given the burden on nations resulting from these large reductions, and oil producers' well-known history of cheating, the current price of $14.70 a barrel may not stick.
If anything, moreover, the size of the announced cuts shows the extent to which OPEC is hostage to the fiscal difficulties that the prolonged period of depressed oil prices has caused.
Last week's announcements do not guarantee an immediate end of the bear market. Last March an agreement among Saudi Arabia, Venezuela and Mexico led to a sharp rally in oil prices. Reality set in later, as cheating resumed. Prices fell to their lowest levels in 12 years, as national politics -- not global industry fundamentals, notably the economic downturn in Asia -- drove output decisions.
And as recently as just two weeks ago, OPEC members were complying with only 77% of their stated production cut goals. Further, data on crude oil and its product inventory clearly do not support higher prices. Supplies of crude rose 4.7 million barrels last week, gas inventories increased the equivalent of 3.1 million barrels and, perhaps even more telling, there are 42 million more barrels of petroleum stored currently than a year earlier.
Thus, to some extent, oil prices are now caught in "a frenzy of speculative buying, which could end in a sharp decline," says one veteran trader.
Moreover, since oil prices tend to strengthen this time of year as refiners gear up for the peak gasoline demand of the driving season, the market should expect some pullback once it gets past two events -- OPEC's March 23 meeting, where the announced accord will be concluded, and the building of gas stocks.
So what exactly happened last week to get the oil market so pumped up? Essentially, four events. First, Iran and Saudi Arabia reached an important compromise on Iran's baseline production level of 3.6 million barrels a day. Previously, Iran had maintained that its base level was 3.9 million barrels; now it will use the lower figure as the base from which new cuts will be made.
Sorting out this issue was critical to discussions about any future production cutbacks. Also, the deal was important because it showed a greater willingness by Saudi Arabia -- the world's largest producer, the instigator in this latest round of cut-back discussions and the most credible OPEC member when it comes to achieving reductions -- to shoulder more weight than it has in the recent past since it ceased being OPEC's swing supplier.
Second, a broader group of OPEC nations then met in Saudi Arabia. This group, known as the Gulf Cooperation Council, lent its support to the understanding, which was another key ingredient in working toward a cutback.
Third, on Thursday, Saudi Arabia and Iran took their plans outside of OPEC to embrace other significant world producers such as Mexico and Venezuela, which had said no fewer than three times last week that it did not plan to cut its oil output further.
Fourth, on Friday, the announcement came that oil ministers had agreed to "an output cut over two million barrels per day over and above previous commitments, to be implemented by OPEC and non-OPEC countries as of April 1, 1999," said the communiqué.
Thus, while the near-term outlook for crude is bearish, John Saucer at Salomon Smith Barney thinks a $17 price by yearend is "conservative," and "it may be higher than that." Still, he hedges that forecast: "We learned last year that good solid cuts are not enough to turn this market."
Beyond oil, cotton, grains and even gold all staged impressive rallies last week, bringing the Bridge-CRB Index to 188.28 from 186.53 one week earlier. Yet the persistent deflationary problems plaguing commodities -- such as noneconomic excess capacity and therefore a lack of pricing power -- continue to point to more of a bear-market bounce than the beginning of a major turning point in most markets.
KEY COMMODITY INDEXES
CRB Group Indexes 3/12 3/05 Yr. Ago
CRB Futures 188.27 186.53 226.00
Industrials 179.18 181.84 222.69
Grain/Oils 168.99 165.54 215.44
Livestock 217.38 220.24 225.87
Energy 145.19 139.53 160.76
Precious Metals 239.88 239.12 257.52
BARRON'S ~ Bridge Telerate
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