As I write this piece, we are still awaiting the official announcement of the outcome of the OPEC+ meeting in Vienna, but given the organization’s penchant for controlled leaks, and given that every major news organization is reporting a million barrel a day increase in output it is fair to assume those reports are accurate. So, as always, the question is what this means for traders and investors, and how can they profit from it?
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Any analysis of the potential impact must start with what didn’t happen. Contrary to what was said by some going into this meeting, the different objectives and needs of OPEC’s various members did not result in the breakup of the cartel. For future reference, nor is it likely to any time soon. OPEC is, despite being inherently as anti-free-market as you can get, a great example of why capitalism works. When nations as diverse and divided as Saudi Arabia, Iraq, Iran and Venezuela can come together to maximize profit it is an indication of the power of the greed that moves markets, and that power should never be underestimated.
Secondly, as this Wall Street Journal article accurately states, while the crude oil output limits have been technically raised by a million barrels a day, the reality will fall well short of that number. The main proponents of an increase, Russia and Saudi Arabia, both have the existing capacity to increase immediately, but that is not true everywhere. By dividing up the nominal increase amongst all signatories to the agreement, the cartel has been able to announce a million-barrel increase, give the powerful Saudis and Russians what they want, and yet limit the actual increase in crude supplies to around 600k barrels a day. You may dislike the anti-competitive nature of OPEC or be afraid of the power they wield, but it is hard not to admire their ability to get what they want while managing the narrative.
So, now that everyone is happy, what does that mean for the price of oil? The market spiked initially as the news became known, but then, as tends to happen following a news driven move, started to retrace.
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Obviously, at this point I cannot know what the rest of Friday’s trading will bring, but from a long-term perspective this has to be supportive of crude. The increase represents around a half of one percent of global demand and is less than half the IEA estimate for demand growth in 2018 and 2019. The IEA expects North American output to largely fill the gap, particularly from the U.S., but output from Venezuela continues to fall precipitously and once the U.S. sanctions begin to bite, Iran’s exports will all but disappear. In short, the million-barrels a day increase is nothing of the sort, and when other factors are considered, starts to look like the proverbial drop in the ocean.
That doesn’t mean, however, that oil will soar. What it will do is shift the focus of traders to the demand side, but there is plenty of risk there to keep a lid on price increases in crude. It looks increasingly like Wall Street is seriously underestimating Donald Trump’s appetite for a trade war, for example. This is not an administration marked by consistency, but tariffs and the wall have been two constant themes of Trump, both as a candidate and as President. Even if the bulls are right and this eventually turns out to be just posturing as a negotiating tactic, a lot of damage can be done to growth prospects while that plays out. Add in the fact that both the People’s Bank of China and the ECB are joining the Fed in moving towards tighter monetary policy and the prospects for global growth and therefore oil-demand growth are not as rosy as it may seem at first glance.
So, we have a situation where supply is still being restrained, but with a slight, maybe even completely insignificant increase, but the demand growth that has driven oil higher is being called into question. The only conclusion that can be drawn from that, as unsexy as it is, is that we stay roughly where we are. $60-75 is a wide range, but it is a treasonable one to expect as the dust settles from this news. As it stands though, the announced increase will probably have no impact and the fears about growth are just that, fears. In the short-term therefore I would probably favor a long position in expectation of trading near the top of that range for a while, but we shouldn’t get too carried away by this mornings news.