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"A Classic Head Fake": Why One Trader Is Using The Saudi Turmoil To Sell Crude

Overnight, following the recent Saudi turmoil, prices in the crude complex jumped to the highest levels in over two years, amid speculation that Saudi Arabia is more likely to back output curbs following this weekend’s crackdown by Crown Prince Mohammed bin Salman. "It creates some hope that the current policy by the Saudis will be continued after March,” said ABN Amro senior energy economist Hans van Cleef. "We’re still in the longer-term upswing, the uptrend is still intact", and indeed Dec. WTI rose +31c to $55.95/bbl after earlier touching $56.28, the highest since July 2015, while Jan. Brent was also up +35c to $62.42, after rising to $62.90, highest since June 2015

And yet not everyone believes that the recent chaos in Saudi Arabia is a bullish catalyst for oil: taking his usual contrarian stance, Bloomberg commentator and ex-Lehman trader Mark Cudmore writes that what happened is "largely irrelevant" for oil prices and the resultant oil price spike has "the look of a classic head fake and may mark the final push higher before a correction."

Attacking the key point underscored by oil bulls, Cudmore says that "an extension of OPEC supply cuts is fully expected by the market, and the weekend changed nothing on that front" meanwhile "oil prices are still dominated by the overhang of potential supply that can come online so easily from U.S. shale fields. The rig count may have been dropping recently, but it remains 62% above the level of a year ago. And, crucially, U.S. production is near the highest in more than two years, according to the Energy Information Administration."

Furthermore, Cudmore is confident that what is taking place with oil is "narrative drift" and goalseeking to justify a bullish bias as "there’s been a preponderance of bullish oil notes during the past week. Drawdowns in global inventories are getting investors excited, especially since crude trades at the highest levels in more than two years. But stockpiles are still very large historically and it’s the elevated price which makes oil look so vulnerable." Meanwhile, positions are at an extreme, with "long positions are the most stretched since March according to Friday’s CFTC data" while "Less talked about news from the weekend was Mexico announcing the largest onshore oil discovery in 15 years. That’s only going to impact supply in the long-term, but it may remind traders that the overall macro dynamics of the oil market haven’t changed -- not least from some domestic political news in Saudi Arabia."

In short: Cudmore is happy to take this opportunity to reset short positions not only because the current oil price spike will send US production into overdrive but because "demand growth will continue to be undermined by innovation in other energy fields, while technology keeps reducing the cost of extraction and production. Those factors are both very long-term but a potentially misunderstood news- driven spike may be a good time to focus on them again."

Incidentally, Cudmore's note is precisely what the WSJ discussed overnight in "Saudi Crackdown Doesn’t Guarantee Aramco IPO – Or Higher Oil"

Mark Cudmore's full note below:

Oil Prices May Be in the Process of Topping Out: Macro View

 

Crude prices jumped at the open Monday on largely irrelevant news from Saudi Arabia. It’s got the look of a classic head fake and may mark the final push higher before a correction. 

 

The purge in Saudi Arabia is more of a domestic story. Crown Prince Mohammed bin Salman was already perceived to be driving the country’s oil policy, so consolidation of his power shouldn’t result in any strategic shift.

 

An extension of OPEC supply cuts is fully expected by the market, and the weekend changed nothing on that front.

 

Oil prices are still dominated by the overhang of potential supply that can come online so easily from U.S. shale fields. The rig count may have been dropping recently, but it remains 62% above the level of a year ago. And, crucially, U.S. production is near the highest in more than two years, according to the Energy Information Administration.

 

There’s been a preponderance of bullish oil notes during the past week. Drawdowns in global inventories are getting investors excited, especially since crude trades at the highest levels in more than two years. But stockpiles are still very large historically and it’s the elevated price which makes oil look so vulnerable.

 

Long positions are the most stretched since March according to Friday’s CFTC data.

 

Less talked about news from the weekend was Mexico announcing the largest onshore oil discovery in 15 years. That’s only going to impact supply in the long-term, but it may remind traders that the overall macro dynamics of the oil market haven’t changed -- not least from some domestic political news in Saudi Arabia.

 

Demand growth will continue to be undermined by innovation in other energy fields, while technology keeps reducing the cost of extraction and production. Those factors are both very long-term but a potentially misunderstood news- driven spike may be a good time to focus on them again.