The New OPEC+ Deal May Not Cause A Real Rally In Oil

The early reaction in oil futures following this morning’s announcement by OPEC and its partners in the production cuts that they will cut by another 500 thousand barrels per day is probably mystifying to some people. To those who understand the way markets work, however, it should come as no surprise.

What is remarkable is not the initial surge, but the pullback that quickly followed. That move has nothing to do with the size of the cuts, it is a function of what came before.

Crude futures had already risen this week as the view that cuts were coming gained traction. What we are seeing this morning is not quite a “buy the rumor, sell the fact” pattern, but it is based on the same thing. If everybody is already positioned for expected news, the reaction will inevitably be muted and profit-taking will cause the opposite to the logical reaction.

The question is though, does that mean that the market will stall out here?

Logic dictates not, but that isn’t the end of the story.

Half a million barrels a day would be a significant supply adjustment at any time, but coming as it does at a time when there is no real glut of oil in the world, it is hard to see how it cannot continue to give oil a boost. At the very least, it will put a floor on prices, making short trading an unattractive proposition.

What the decision to cut has done is to take some of the uncertainty out of the equation on the supply side, so the focus will return to demand. That, however, may not be good news for oil prices in the long-term.

Oil demand expectations are largely a function of developments in the trade war between the U.S. and China. This morning, after a blowout jobs report for November, we began to see the uncoupling of U.S. equities from that dynamic, but it would be wrong to assume that oil will do the same. Stock traders pushed all the major indices higher on the report, and even when Larry Kudlow said that Trump is prepared to walk away from negotiations if certain conditions aren’t met, that spike continued. Not too long ago, that would have overshadowed the good news, but not this morning.

There is an increasing realization that the American economy is doing fine, tariffs notwithstanding, but that isn’t the whole story as far as oil is concerned. It enables the U.S. to negotiate a trade deal from a position of strength, but only if the same cannot be said of China, and the jury is still out on that. The most recent data was encouraging, but the longer-term trend in Chinese growth is still a concern to a global market like oil.

So, while it may seem that the jump in crude is the logical move and the pullback isn’t, the opposite may be true. It is not that the cuts won’t have an effect. They will, but the demand side of the equation is still a long-term overhang. There is also the fact that any surge in prices would recreate the conditions for further increases in U.S. shale production, so energy investors would be wise to temper their enthusiasm on this morning’s news.