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The Pen Is Mightier Than The Pump: The Danger Of Shorting An OPEC Deal

Oil Rigs

Around the time of the February oil crash, we first mused whether OPEC had developed a curious habit of jawboning oil prices higher with the help of flashing headlines at times of peak short positions among the hedge fund community, to launch HFT-momentum facilitated short squeezes.

We followed up most recently in an August post, when we said that "OPEC started releasing tactical headlines at key inflection points about an imminent oil production freeze (which not only never arrived but has since seen Saudi Arabia's output grow to record levels) which we first suggested were meant to trigger a short squeeze among headline scanning HFT algos, our suggestion was - as is often the case - dismissed as yet another conspiracy theory, although we admitted that "one can debate whether OPEC's "headline" leaks are timed to coincide with near-record short positions on WTI."

Fast forward several months later, when the question whether OPEC tactically times its statements to inspire short squeeze is the core topic of Morgan Stanley oil analyst Adam Longson's latest weekly report, in which he writes that while oil may continue to decline, he "would be nervous being short from these levels going into the meeting despite what appears to be a poor fundamental backdrop and our downbeat outlook for 2017." The reason: OPEC "has repeatedly made bullish announcements about OPEC intervention during periods of low liquidity (e.g. U.S. holidays), and whenever short positions become large."

Longson then warns that "if prices continue to slip, the chances for bullish OPEC headlines grow, which could lift prices briefly even if there is no follow through. OPEC desires a price above $50 and historically has started to talk whenever prices slip below $40. Thus, the cartel may choose to announce a headline deal to lift prices, even if there is no plan to execute it." His advice to traders: "Watch speculative short positioning, especially as prices erode."

In taking an amusing adage about trading against central banks, Longson adds that "investors have proven that they are not willing to press short positions against OPEC, even if the odds of intervention are low. In essence, this is similar to the old adage of “Don’t Fight the Fed.” Related: Why Should Investors Take OPEC Seriously Anymore?

Below is the key section from his latest weekly note:

Be Careful About Getting Too Bearish Ahead of OPEC Meeting

Poor fundamentals don’t prevent headline-related price reversals. Skepticism about the ability for OPEC to execute on its Algiers agreement is warranted. A number of producers are claiming exemptions, OPEC production is rising, greater cuts may be required to achieve the top end of the range, and OPEC has a poor compliance history. Reuters also suggested that Saudi Arabia threatened to raise production, and former Saudi Energy Minister Ali Al-Naimi stated that OPEC can’t cut by itself. Nevertheless, we would be nervous being short from these levels going into the meeting despite what appears to be a poor fundamental backdrop and our downbeat outlook for 2017.

OPEC can still spook markets. Although OPEC’s actions have not matched its words (i.e. promoting the need for production restraint while quietly growing production), the cartel has become adept at talking up declining markets. The group has repeatedly made bullish announcements about OPEC intervention during periods of low liquidity (e.g. U.S. holidays), and whenever short positions become large. Despite the fact that many investors are skeptical of OPEC’s ability to change the outlook, prices still move on these headlines. Investors have proven that they are not willing to press short positions against OPEC, even if the odds of intervention are low. In essence, this is similar to the old adage of “Don’t Fight the Fed.”

If prices continue to slip, the chances for bullish OPEC headlines grow, which could lift prices briefly even if there is no follow through. OPEC desires a price above $50 and historically has started to talk whenever prices slip below $40. Thus, the cartel may choose to announce a headline deal to lift prices, even if there is no plan to execute it. In other words, plenty of uncertainty and event risk remains. Watch speculative short positioning, especially as prices erode.

Related: OPEC Chaos Sees Oil Prices Fall

Swings in short positioning have coincided with many of the moves in oil this year. If shorts are emboldened by weakening fundamentals and fading confidence in OPEC, it’s possible for short positions to build. Along with lower prices, such developments generally bring strong bullish words from OPEC. Already we have heard supportive rhetoric. Algeria’s Energy Minster stated he is confident OPEC members will stick to the Algiers agreement. OPEC’s Secretary General noted that the cartel has made "significant progress" and is "on course" for a deal on Nov 30.

It is almost as if a major western investment bank(s) is coordinating not only OPEC's diplomatic strategy, but also advising the cartel just when to generate the flashing red-headlines to get the most bang for the buck...

By Zerohedge

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