Prepare For Another Shift In Mood In Oil Markets

No matter how many times I witness it (and after nearly thirty years in and around financial markets that number is probably in the thousands) the fact that the mood of a market can change on a dime with no obvious change in circumstances still amazes me. That is what happened in the oil futures market a week or so ago, when the positivity surrounding the upcoming OPEC agreement to cut production changed to doubts that the deal would hold or have the anticipated effect. Nothing had actually changed with respect to the agreement, but somehow the market’s perception of it shifted. As the actual meetings approach over the next week or so though, a return to a positive outlook, and higher oil as a result of that mood change, looks likely. If we break cleanly through $55.50 this time we could even see a challenge of $60, a level that some thought would never be seen again.

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The evidence for that assertion is historical. As each round of talks that have led to this agreement has approached the market has taken a positive view of the possible effect on oil prices. The feeling seems to be that after such an extended period of pain due to low prices any differences between OPEC countries will be overcome by the desire for more revenue from oil. So far that seems to be the case, although the retracements after the fact reflect a somewhat different reality.

Firstly, even if OPEC does cut production, the price driven cuts in exploration and production in North America could fairly easily be reversed to offset at least some of the reduction. Secondly there is the nagging feeling that coming to an agreement and sticking to it are two different things. If the agreement were to be broken it wouldn’t be the first example of duplicity from OPEC members nor, given the ongoing conflicts in the region, would it really come as a huge surprise. Those harsh facts may come into play over time as the real effects of the agreement become known, but they will not be in focus next week.

Instead, the pre-meeting meeting between seven OPEC energy ministers and the meeting itself to finalize and set an enforcement mechanism for the agreed cuts will most likely result in higher oil prices in the short term. There are, after all, only positives to be garnered by the participants if they, at least in public, present a unified front, determined to ignore their differences and force up oil prices around the world. A group of smiling delegates posing for a photo-op and proclaiming an historic agreement is therefore far more likely than anyone storming out of the meeting.

On that basis a period of positive sentiment, albeit a potentially brief one, looks on the cards over the next week or so. China’s increased imports in Q4 that were reported this morning and the general expectations for growth and a more inflationary environment following the U.S. election will be quoted as additional reasons for the strength. Meanwhile, inconvenient details like the fact that the Fed will be raising rates three times this year and that the dollar is stubbornly hovering around multi year highs will be ignored…at least until the next time the mood changes.