Oil traders face 'big punishment' if OPEC doesn't deliver output cuts

Trading block: Oil and currencies
Trading block: Oil and currencies

Speculators have been increasing their bets that oil prices will rise, setting up a punishing outcome if OPEC's production cuts disappoint, Again Capital founding partner John Kilduff said Thursday.

OPEC not only faces the challenge of getting its own members to deliver the promised cuts. It must also contend with potentially weaker demand in China and the threat of rebounding U.S. production, Kilduff said.

"The boat is loaded to one side in the market right now. Shorts have covered. People have piled in from the long side, waiting for these cutbacks to come through. If they don't, there's going to be big punishment in this market," he told CNBC's "Squawk Box."

Members of the Organization of the Petroleum Exporting Countries are scheduled to begin cutting production next week, and other producers have committed to reducing their output in the first half of 2017. The producers are aiming to reduce huge stockpiles of oil that built up after a boom in production caused in large part by a revolution in U.S. drilling.

Demand may not hold up

Kilduff acknowledged that crude demand could get a boost if President-elect and congressional Republicans deliver anticipated tax breaks and government stimulus that lead to economic growth at home and abroad.

However, he said he doesn't see that translating into higher demand in China, the world's second-largest oil consumer.

"That's the real demand center. That's the swing place, and I still see issues there," he said.

Kilduff, a longtime skeptic of OPEC's ability to deliver output cuts, has warned throughout the year that slowing economic growth in China and elsewhere in Asia is the oil market's Achilles' heel.

2017 crude oil outlook: Pro
2017 crude oil outlook: Pro

He is not the only one who sees red flags in China. On Tuesday, ClipperData's director of commodities research, Matt Smith, cautioned that rising oil prices could crimp China's opportunistic buying. Throughout 2016, oil producers competed fiercely for China's business, allowing the country to hunt for bargains and fill up its strategic reserves.

The rising U.S. dollar also threatens to dent oil demand because a stronger greenback makes crude more expensive to holders of other currencies, Stephen Schork, editor of The Schork Report, told "Squawk Box" on Wednesday.

Supply is a problem too

China also presents a supply problem. Small refineries known as teapots have sprung up throughout the country, helping to boost employment in China, but also contributing to a glut of refined petroleum products like gasoline, Kilduff said.

"You saw a big increase in their crude oil demand to feed those refineries. The problem is that they just turned that all right around and exported the refined product to the global market, particularly out in Asia," he said.

Kilduff said there is simply too little demand on the horizon, and the figures behind forecasts that oil demand will exceed supply by the second half of 2017 don't add up.

That is partly because he doesn't believe OPEC and other oil producers will adhere to output cuts and partly because higher oil prices in the wake of that agreement are stimulating U.S. production.

He noted that U.S. output has risen in recent weeks, and steady additions to the domestic rig count signal more American crude is on its way.

Schork said the oil market has likely reached a top at $53 to $55 a barrel. He noted that U.S. producers have been able to lock in $55 a barrel or more for future deliveries, a price that allows more drillers to pump profitably.

Higher U.S. production puts downward pressure on oil prices because it is seen as preventing the market from burning through a global oversupply of crude.

People work at the Halfaya oilfield in Amara, southeast of Baghdad, Iraq.
Essam Al-Sudani | Reuters