Complex Made Simple

Should investors bet on OPEC agreement?

Rising uncertainty about whether OPEC agreement to reduce oil production is achievable

Many countries have backed out of supporting the agreement

Until clarity is reached, any bets would need to take risks into account


Now that the initial excitement about the tentative OPEC agreement to reduce oil production has died down, uncertainty over whether the deal is achievable is rapidly resurfacing. The last meeting in Vienna showed OPEC members rapidly backing out of the supporting side for a production cut. Iraq and Iran were early retirees and now Nigeria, Libya and Indonesia are heading towards the bench.

The best market reaction gauges are WTI Crude and Brent, with both standards showing recent downward trends, shedding around $5 per barrel at the beginning of November and putting prices back to where they were before the Algeria talks. Given the uncertainty, should investors bet on OPEC agreeing at the Vienna meeting on November 30? The answer lies in whether positive sentiment can be sustained in the face of bearish fundamentals.


(Read how OPEC is playing a chicken game)


September talks

The cartel benefited from its September talks in Algeria, managing to improve sentiment towards black Gold to the extent that it moved through the $50 level and started heading towards $52 per barrel. Improved sentiment leads to higher expectations though, leaving oil vulnerable to steep declines when they’re disappointed.

Already, the $5 per barrel loss means that an unwelcome basement floor is heading rapidly into view, accelerated by reports of record October production levels by OPEC members Libya and Nigeria.


(OPEC’s job just got tougher with Trump win)


At the same time, US crude stockpiles were boosted by 14.4 million barrels for the week ending October 28, making it the largest weekly build since the US Energy Department started keeping records in 1982 and adding to existing doubts that an OPEC production cut can seriously dent the over-supply on the world oil markets.


Going into overdrive

Uncertainty is also building that Saudi Arabia would accept to reduce its own production while other OPEC members like Iran continue to go into overdrive and snap up more market share. Potential market drivers like the conflicts in Yemen, Syria and Bahrain, and the economic crisis in Venezuela, should also be taken into consideration as they may affect sentiment by triggering supply fears. However, so far, this has not been a major factor in 2016, given the worldwide oil glut stemming from US shale and record OPEC production levels.


Russia connection

What of Russia, which has been lobbying to join OPEC in a production freeze for the past year? So far, the potential deal hasn’t materialised and it appears that it’d take exceptional circumstances to bring the world’s gigantic oil-producing interests onto the same page.


(IEA: no OPEC cut means another oil surplus in 2017)


Circumstances that might qualify could be a dramatic fall in the price, for example, a fall so drastic that oil-linked currencies take a hit that demands urgent action. Even under those circumstances, however, US shale oil production would continue to present a ceiling to the lowest floor.

A freeze or cut in OPEC and Russia’s production could be short-lived due to a quick recovery in US shale oil production. As was seen most recently, US shale oil firms were not sitting on their hands when prices spiked, in fact they hedged their risk by selling into the rally.


Concrete action needed

While sentiment towards oil sees short-term boosts on the promise of an OPEC production cut, at some point the trading markets would need to see concrete action, and this point is rapidly approaching on November 30, when the world’s attention will be focused on Vienna.

Until clarity is reached, any bets on an OPEC production cut would need to take the risks into account, hedging for downsides like last-minute disagreements over the tentative deal.