Oil Plunges Again–What’s Next?

Oil prices went into free fall today, continuing the bear market in the commodity.

U.S. benchmark West Texas Intermediate fell 7.73% on the day to $55.30 a barrel. International benchmark Brent dropped 7.05% to $65.18 a barrel.

Yesterday oil had rallied on news out of Sunday’s OPEC gathering that Saudi Arabia would cut production by 500,000 barrels a day in December. The hope in the market was that this might be the beginning of a shift in OPEC-wide policy toward reversing a year’s worth of production increases by the cartel and moving to a policy of production cuts designed to defend oil prices of $70 a barrel for the Brent benchmark.

That possibility took a severe blow when U.S. President Donald Trump went on Twitter Monday afternoon to criticize the Saudi move.  “Hopefully, Saudi Arabia and OPEC will not be cutting oil production. Oil prices should be much lower based on supply!” he posted on Twitter.

So where do we go from here? The important date to remember is December 6. Mark it on your calendar. It’s the date of the next full meeting of OPEC.

Alternative #1: Opposition from the U.S. President, U.S. influence with the current Saudi regime, and internal disarray among OPEC producers will be enough to prevent any change in OPEC production targets. OPEC–and Russia–will continue to produce at something like current rates. And that will lead to continued fears of a surplus supply in the market as U.S. production continues to grow and as growth rates in the global economy threaten to slip lower. If you believe this alternative, then you should be investing as if oil prices will continue to fall further.

Alternative #2: With oil in a bear market, falling prices put so much pressure on OPEC to cut production in order to support oil prices at the $70 level that nothing else much matters. OPEC and Russia will move to cut production–by as much as 1 million barrels a day from current historic highs–at the December 6 meeting. Today’s 7% plus drop in the price of oil was a sign of market capitulation and marks the bottom for this cycle. If you believe this alternative, then you should be investing as if oil prices will soon start to rise as the December 6 meeting approaches.

My own vote goes to Alternative #2. I think we’re near a bottom for this plunge and that we will soon start to see oil prices start to move up.

I also believe, however, that a cut in OPEC production of 1 million barrels a day will only temporarily stabilize oil markets. U.S. production is just growing too fast and global demand is just growing too slowly for a quick 1 million barrel a day cut to do the trick. I think there’s a good likelihood that after a sharp rally in oil, we could quickly see a replay of the current downward plunge in the first half of 2019. That’s especially likely if U.S. oil shale producers in the Permian Basin fix their transportation bottlenecks by the middle of 2019.