Editor’s note: It’s getting difficult to find a bull on the price of oil. In this analysis, originally posted on 11-2-06 at www.joe-duarte.com, Dr. Duarte explores the possibility that a rally in crude oil could be around the corner.

OPEC: Few Believers Left
Is This A Contrarian Opportunity?

Traders and analysts are in agreement with regard to OPEC's inability to deliver on its production cuts of 1.2 million barrels per day. With few left in the market with faith in the cartel, the possibility of a market rally in response to a surprise might be on the rise.

To be sure, it's hard to bet against OPEC's past record of saying one thing and doing another. Yet, there are so few left willing to suggest that the cartel might actually pull it off this time that we have to wonder if this may not be a time to be careful.

According to the Wall Street Journal: "skeptics are still jeering now that the self-imposed Nov. 1 deadline has passed with scant evidence that the producer group as a whole will cut output of 1.2 million barrels of crude oil a day."

In fact, the Journal quoted one analyst as saying that the production cut agreement is so "full of holes" that it resembles "Swiss cheese."

Instead, there are those that suggest that "oil prices are more likely to rise on healthy global economic growth and a possible cold winter in the Northern Hemisphere than on OPEC's announced output cuts."

Yet, if the U.S. economy continues to slow, as indicated by weak readings in the recently released survey from the Institute for Supply Management, oil demand, based on economic growth might not rise very much, at least in the U.S.

Which, of course, leaves China and India as the driving demand sources. China's economy, by all available data is still growing, although it is difficult to pinpoint whether its growth rate is sustainable at the most recently reported 15% annual rate. India, on the other hand, has recently raised interest rates, a sign that its growth rate remains robust enough for its central bank to move rates higher.

OPEC Members Mixed On Cuts

So, if OPEC's cuts don't matter, it's important to see who might be doing the cheating.

According to the Journal, at least two members have made good on the cuts: “Saudi Arabia has confirmed it is slicing output by 380,000 barrels a day. The United Arab Emirates has also confirmed in letters to refiners that it plans to cut output in November by 101,000 barrels a day."

Yet, others have not. Indonesia has said it does not plan to cut its output. The only Asian member of OPEC "said it shouldn't have to cut its agreed share of 39,000 barrels a day, because it is a net oil importer."

More interesting is this: "Oil analysts and customers of Venezuela, Nigeria and Iran, among other OPEC states, say they have yet to see concrete evidence that oil deliveries from those countries will be reduced in November by the agreed-upon levels, if reductions are made at all."

Nigeria is no real surprise, given the fact that its political instability makes any kind of quantification difficult.

Venezuela, though, has been a big proponent of production cuts. Yet, it is well recognized by the markets, that Venezuela is likely to be inflating its production numbers, and that it has been doing so for several years.

As we reported here (See), there is at least one instance reported in which Venezuela had to buy Russian oil to meet contractual obligations.

In that report, dated May 2, 2006, we wrote: 'According to the Financial Times: "Venezuela, the world's fifth-largest oil exporter, has struck a $2bn deal to buy about 100,000 barrels a day of crude oil from Russia until the end of the year. Venezuela has been forced to turn to an outside source to avoid defaulting on contracts with "clients" and "third parties" as it faces a shortfall in production, according to a person familiar with the deal. Venezuela could incur penalties if it fails to meet its supply contracts."'

Conclusion

The market is skeptical about OPEC's willingness to stick to its production cut agreement and history is not on the cartel's side.

Yet, as any experienced trader will tell, when the majority is on one side of the trade, it's a good idea to explore the other side.

In other words, if prices don't take a big dive soon, it might be a good idea to cover short positions and wait to see what happens.

© 2006 Joe Duarte, M.D.
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