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Oil price volatility has picked up as traders position themselves for tomorrow’s key OPEC meeting in Vienna. Just yesterday, both Brent and WTI sold off in early trade only to bounce back sharply later in the session. The price swings followed rumour and counter-rumour as significant parties jockeyed and sparred with eachother in a particularly high-stakes game of “crude poker.” At the end of last week oil prices slumped after Saudi Arabia said they would not attend yesterday’s pre-meeting of OPEC and non-OPEC producers. However, the rally came when it was reported that Iraq’s Oil Minister Jabbar al-Luaibi was “optimistic” that a deal could be reached.

Back at the end of September there was an informal meeting of OPEC ministers in Algeria. The 14 members surprised markets by not just agreeing to an output freeze but announcing they were planning an actual reduction. The news saw crude prices rally to retest highs hit back in early June.

However, analysts were highly sceptical of the OPEC announcement. First of all, it followed on from April’s failed meeting in Doha to agree to an output freeze. This broke down with no agreement and bad feeling between Saudi Arabia and Iran. On top of this, there were precious few details about how an output cut would be achieved. For a start, it was unclear which countries would bear the brunt of any cuts or how compliance could be ensured. In addition, Iran, Iraq, Nigeria and Libya all claimed they had good reasons to be exempt from any cut or freeze. Then there were questions concerning non-OPEC producers. Production cuts would have little overall effect if significant producers such as Russia didn’t also agree to take part.

At the September meeting in Algeria OPEC said it planned to target a production cap that would hold output to between 32.5 million and 33 million barrels per day (bpd). At that time OPEC output stood at 33.24 million bpd, implying an overall cut of between 240,000 and 740,000 bpd. Since then OPEC production has risen to 33.64 million bpd.Bear in mind that projected demand for OPEC crude in 2017 is 32.5 million bpd (the lower end of the cartel’s target). So this suggests OPEC now needs to cut production by over 1 million bpd just to keep supply and demand in balance.

The most recent betting is that an agreement will be reached tomorrow. However, there is still no evidence that any accommodation has been reached with Iran. The country is pushing for an exemption (along with Iraq, Nigeria and Libya), yet Tehran and Saudi Arabia still appear to be at loggerheads. Iran has accused Saudi Arabia of exploiting turbulent conditions such as Iran's oil sanctions, Libya's internal conflicts, technical issues in Venezuela's oil industry and militant action around the Nigerian Delta.

Here are a few observations ahead of the OPEC decision:

1.As with Doha in April, the meeting breaks down with no agreement and bad feeling between Saudi Arabia and Iran. This could put pressure on the oil price and crude could retest support around the August lows ($40 for WTI and $41.50 for Brent).

2. OPEC members (and Russia) agree to cut production. This should help oil to rally initially and retest resistance ($52 for WTI and $53.50 for Brent).

3. But look out for exemptions (Iran, Iraq, Nigeria and Libya). If these countries are exempted, then a large production cut (anything from 700,000 to 1,000,000 barrels) isn’t realistic as the burden will fall disproportionately on Saudi Arabia (which can’t afford to lose anymore income from oil exports).

4. Back in April the lack of agreement hardly caused a hiccup in crude’s rally. But this time round, things could be different. Both WTI and Brent have repeatedly run into resistance just above $50.

5.But compliance is particularly important. Even if a deal is agreed, it’s very unlikely that everyone will stick to it. After all, OPEC members have never had a quota that they haven’t ignored. In short, an OPEC agreement might spark a short-term rally, but unless the cartel agrees to real and sustained cuts, the poor fundamentals could ensure the price increases are temporary.

Ultimately though, any production cut simply plays into the hands of US shale oil drillers. The US is now the world’s swing producer, and US production will increase if oil can find support above $50. Just last week International Energy Agency (IEA) Director Fatih Birol told Reuters that oil prices could come under downward pressure even if there is a cut. He expects US shale oil producers to take advantage of higher prices to increase output. It’s already creeping back up. According to Baker Hughes, the US rig count has been climbing for half a year, and as of 25th November stood at 593, up by almost 200 since May. Gains in the rig count will only pick up pace of OPEC agrees to cut its output.

It’s also worth bearing in mind how things may change with a Trump presidency. Mr Trump has promised to cut regulations which have held back US production. He has vowed to support the industry and expand drilling on federal land. All-in-all, this suggests increased US supply while the outlook for global demand growth is less certain. Looking forward, it could be that crude finds itself capped in the low to mid $50s, while support should continue to come in around $40.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: PM Bulletin


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