Oil Update

It may not be on your economic calendar, but on July 24 OPEC meets in St. Petersburg, and there is a reasonably good chance that efforts to bring Libya and Nigeria into the quota system may succeed. According to a report from the OPEC Secretariat that draws on secondary sources (apparently national sources are not reliable).

Libya's output is up 460k barrels a day since the start of the year, while Nigeria's output has risen 175k barrels a day. Civil wars in both countries had reduced output, and therefore were not included. Libyan output is its highest in couple years, but still only a little more than half of its 2014 peak. Nigerian output is just below 1.8 mln barrels a day, a level that officials previously seemed receptive to capping.

Most other OPEC countries have reduced output this year. In addition to Libya and Nigeria, output increased in two other countries: Iran and Iraq. Iraqi output put has risen 110k barrels a day this year. Half of the increase took place in June. Iran boosted its output by 270k barrels a day this year. This was largely a Q1 phenomenon. In Q2 Iranian output was virtually unchanged just below 3.8 mln barrels.

OPEC's challenges are internal not just external. There is some risk of compliance going forward, especially if there does not appear to be much appetite for deeper cuts or a longer extension. That said, the increase in Saudi output is not a harbinger of their defection. What is often forgotten is that Saudi Arabia is one of the few countries that burn oil for electricity. It often boosts output in the summer months to meet the electricity demand associated with increased air conditioner use.

US oil inventories have fallen by a dramatic 13.8 mln barrels over the past two weeks. This is the largest two-week draw since early last September. Nevertheless, we are hesitant about reading too much into it. The reduction in inventories appears to be a function of stepped up refining operations and exports. The refiners worked at seasonally high levels. US is exporting more than 900k barrels a week, an 80% increase over Q2 16. US oil imports have also fallen, allowing China to take the dubious honor of being the largest oil importer in H1.

Outside of the OPEC and the US, the other large oil story this week is the two apparently large finds in Mexico. After many years of dragging its feet, Mexico finally opened up its oil exploration and production to private sector businesses, and it is from this approach that the new discoveries were made. Preliminary reports suggest both fields could hold a billion barrels of oil.

The August light sweet oil futures contract has advanced every day this week. Recall that the price of oil fell for five consecutive weeks from late May through late June In the last week of June it rose by 7% and fell almost 4% last week. It has recouped last week's losses this week and a little bit more. The near-term technical readings are constructive, and the weaker US dollar also helps. Last week's high was near $47.30, and that represents the next target, which also is the 50% retracement of the decline in late May when the price was last above $52 a barrel. Above there is the $48.35 area, which is the 61.8% retracement and congestion from last month.

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