The stunning news of a tentative OPEC agreement out of Algiers caught just about every trader flat-footed. Speculative short positions in oil had been growing, and oil markets and oil stocks rallied spectacularly on the news to rip the guts out of any trader who’d bet on nothing happening at this meeting, as had been the case the four previous times. There’s a lot to unpack here, but first things first: I wouldn’t be fading this move – OPEC is back.
We haven’t been short names in the energy space, quite the opposite – but we had been looking for a retreat in some U.S. shale names for the opportunity to add to core positions. That opportunity is gone. The OPEC agreement, despite its many, many holes, puts a floor under oil I don’t think will ever again be breached.
Here’s a mistake I will never make again, ever since my first days on the floor trading on the NYMEX: Never doubt the words of the Saudis. Every time in my long career that the Saudi oil minister signaled a price shift, whether up or down, they’ve made it happen. I misread a Saudi signal one time, however, in the fall of 2014, when they indicated their desire to pump freely and fight for market share. I lost $15 dollars a barrel in crude price before I remembered what I never should have forgotten and got to the other side of the trade – and I won’t be fooled ever again.
But first, let’s look. The agreement calls for a modest 750K barrel a day reduction in OPEC output, and does not seem to limit Iran, nor does it mention Russian cooperation. On the face of it, Saudi Arabia could easily cut ¾ million b/d and be done with it, but that wouldn’t make any sense for the Saudis – I can’t believe they’d agree to be entirely alone.
But they might agree to be mostly alone: Their hemorrhage of reserve assets, at an average pace of more than $10b a month since late 2014, has clearly caused a moderate panic:
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Yes, the Saudis had the strategy of bleeding the U.S. shale industry white, forcing U.S. producers to go bankrupt and stop producing, and putting the global swing barrel oil threat and responsibility back in the hands of the Saudis.
You’d have to say now that the U.S. shale industry faced this rifle barrel without flinching. With this OPEC announcement, they can declare at least a pyrrhic victory. Through stringent cash control, quick refinancing and secondaries, efficiency gains and concentration on core drilling, the strongest shale producers have continued to survive, if not thrive. It is Saudis that blinked.
The U.S. players that will benefit the most, and are rallying the most strongly off of this news are those with ready acreage that breaks even above $50 a barrel – companies that haven’t taken the foot off the gas pedal much during this downturn, like Pioneer Natural Resources (PXD), Parsley Energy (PE) and Continental Resources (CLR). I won’t chase them here, as they’ve all caught short sellers in the headlights that are scrambling to cover and magnifying their pop, but I will target them as the dust clears. I believe the details of this OPEC agreement, yet to be worked out in November, should give the markets enough pause to lose some interest in these names during October.
And looking at the very few details of the agreement that have been announced, there remain plenty of questions: Who else besides the Saudis will participate? How will the cartel balance the coming production increases from Libya and Iraq? After a long history of disregarding quotas, who’s to believe they can be enforced now? Can the Saudis and Iranians really agree upon anything, considering their overall confrontational stance and real time confrontations in Syria and Yemen?
I say forget all that – I learned something in 1983, my first year on the floor, that I forgot for a moment in 2014. I won’t make the same mistake again.