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 Wednesday 01 June 2016

PM Bulletin: OPEC and the oil price

 

 

There’s a fair amount of interest building in the outcome of tomorrow’s OPEC meeting in Vienna. However, there was considerably more interest in the OPEC/non-OPEC oil producers’ meeting in Doha back in April. That gathering and its complete failure to freeze oil output at January 2016 levels effectively ensured that tomorrow’s event will prove to be of little consequence.
  
When, in mid-February, Saudi Arabia, Russia, Venezuela and Qatar first made public their willingness to freeze oil production, crude had already begun to rally off its multi-year lows. The rally continued despite concerns that a freeze would do virtually nothing to address the supply glut and high inventories overhanging the market. Most analysts were certain that only an agreement to cut production would reduce supplies, and even then history suggested that agreements amongst oil producers were never fully honoured. Yet Brent and WTI both tacked on 48% from their respective lows in January and February to their pre-Doha levels.
  
There were a number of reasons for this. In hindsight, of course, oil was oversold. However, there were still analysts expecting it to head towards $10 per barrel before it got back to $50, so being short wasn’t an unreasonable trade. But then Fed Chairman Janet Yellen signalled that the FOMC had been too hawkish in its December Summary of Economic Projections. This led to a sell-off in the dollar and a rally in everything else. There followed reports suggesting that supply and demand could come back into equilibrium soon than previously estimated. Then the Doha meeting took place.
  
Ultimately the talks broke down. OPEC member Iran wasn’t present at the meeting. Tehran had made it clear it had no intention of cutting back on output as it strove to push production back up to pre-sanction levels. It had looked as if other producers were prepared to exempt Iran from any agreement given the special circumstances. However, Saudi Arabia put the kibosh on any deal which didn’t include Iran and that was the end of that.
  
Despite this, crude oil continued to rally and is now up 20% since the Doha meeting. So again the prospect of a production freeze was not the driver for higher oil. This time round supply disruptions in Canada, Nigeria, Libya and Venezuela helped to keep oil pushing higher as did rising US inventories, an ongoing decline in the US rig count and further talk of supply and demand coming back into equilibrium.
  
But with both Brent and WTI struggling to make headway beyond $50 per barrel, is crude due a correction? Much will depend on the dollar as over the medium to long-term the oil price is negatively correlated to the greenback. So if the likelihood of a summer rate hike from the Fed increases, then the dollar should rise and create a headwind for oil prices.
  
So what about OPEC? Well one thing is for sure and that is the relationship between Saudi Arabia and Iran continues to deteriorate. OPEC members have had their differences in the past, but perhaps nothing on this scale. Both are facing off against each other in proxy wars in Syria and Yemen, and Saudi Arabia had already made it clear it was looking after its own interests when it abandoned production limits at the end of 2014. Neither country has any intention of holding back on production now, and why should they, with crude trading at its highest level since last October? So if there were any restraints on production then the gloves are off now with every producer (including Russia) determined to increase output and export as much oil as possible. OPEC may not be nearly as important as it once was. But this meeting could mark the next leg in the oil price. Whether it’s up or down from here is another matter.
  
David: OPEC members have had their differences in the past, but perhaps nothing on this scale.

  
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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