The Deceptive Oil Support Strategy And Why It Should Be Ignored

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Includes: OIL, USO
by: Gary Bourgeault

Summary

The ongoing oil price support fiction not likely to happen.

How talking about alleged agreements affects the oil market.

Why Russia has little to gain by making an agreement with OPEC.

Response from U.S. shale companies would frustrate strategy.

(click to enlarge) source: sputnik news Click to enlarge

I've been continually watching for media signals concerning the next catalyst it would push concerning the alleged support of the price of oil. It's clear now what that is going to be: a meeting between Russia and OPEC to reach an agreement to cut supply.

It works in a short window at times, as it did as I write, with the price of oil jumping over 5 percent in response to the reports Russia is ready to engage OPEC in serious talks. It's all nonsense to temporarily give the price of oil a boost.

Even though many investors are starting to see the deception surrounding these dubious reports, it does give those looking to make some quick gains a chance to exploit the "news."

What I don't like about it is in regard to retail investors who may not understand the games being played by producers and financial media to generate interest in their reports and as mentioned, provide a short-term means of making some quick money.

I'll show you why you need to ignore these reports and stay focused on the current fundamentals of the industry, which primarily means the supply and demand factor.

Will Russia and OPEC ever meet and agree to supply cuts?

There is only one question to consider when contemplating the idea Russia and OPEC getting together and hammering out a supply cut agreement: what's in it for Russia? The answer to that is nothing.

What value would it add to Russia to lower production, lose market share, and allow OPEC to enjoy a better oil price, while at the same time retaining most if not all of its market share?

That said, what are the odds there would even be an agreement to meet, let alone to cut oil supply? I think they're next to zero.

It would be a big mistake to announce a meeting with the assumption there was a imminent agreement in the near future, than to have the meeting and not agree to any terms. That would cause the price of oil to plummet, not only back to levels prior to any type of announced meeting, but breaking through to an even lower level, as the market would be told there will be no agreement it can count on.

As for Russia itself, its economy is going through extremely difficult times. The idea it will agree to cut supply under these circumstances can't be considered serious in my view. There is also the fact it takes a lot longer to cut and bring back production in the cold regions Russia produces in, which would give OPEC another advantage if cuts were ever made. That's because most of OPEC could almost immediately resume production, while Russia would take much longer to do so.

For these reasons I don't believe OPEC or Russia are really serious about really lowering supply.

Talking about agreements is the new sport in oil

We've already covered the short-term value of making assertions about scheduling talks. There is another side to it which could have an impact over the longer term.

How that could work is OPEC has its next meeting scheduled for June. If there are continual news reports about Russia and OPEC being ready to make a deal, it presumably could keep a bottom on the price of oil, as investors anticipate a possible conclusion to the oil price war.

What will happen if the stories continue to be reported over the next several months is there will be some very short-term price movements of oil - many times during a one-day period - which will be retained in the memories of investors. As the time for the next OPEC meeting approaches, it could result in a longer period of price support until the meeting takes place and the cartel announces things are going to continue on as usual.

This is all based upon psychology, not having any basis in reality or on the fundamentals of the oil market. It's nothing more than an attempt to keep oil prices from totally bottoming out.

I'm not saying it will work, but it does give pause to some investors because it creates uncertainty concerning supply.

Oil producers don't have to have a meeting or any intention of making an agreement. All they have to do is talk about it to get some short-term benefit from it.

Oil price and shale producers

Another thing that will surprise some investors, although not my readers, is even if there was an agreement in place, over the longer term it wouldn't have a lot of impact on supporting the price of oil. It would of course form a higher bottom, but it wouldn't be the impetus such a move would have been in the past.

This price war was originally launched by OPEC in response to U.S. shale companies taking away market share from the cartel. They are more in control of the mid and upper price levels of oil because they can bring oil to market quickly from drilled and uncompleted wells, which as of April 2015, were numbered at about 4,000 in the U.S.

If OPEC and Russia were to come to an agreement, it would raise the price of oil to the point shale producers would become profitable once again, and they would flood the market will oil in response to the higher prices. This is why this is a disruption to the industry and not a supply cycle as in the past, where OPEC could raise and lower supply and keep the price of oil in a fairly tight range. Those days are over.

When relating this to the fictitious supply agreement always just around the corner, it means under the most favorable outcome, where an agreement was put in place, it still wouldn't do what many in the market believe it would do.

This is another reason I consider this a bunch of hype.

Conclusion

With only OPEC members being the beneficiaries of a supply cut agreement, it would be a miracle to see Russia come to the table and let the cartel regain market share at its expense. It would make no sense.

Some may argue the higher price of oil would compensate for the loss in market share for Russia, but that is only an assumption that would be difficult to prove, since it's not going to happen.

As I said though, there is now a ceiling on oil because of the ability of shale producers to quickly bring a lot of oil to market, and because the demand estimates for oil in 2016, led by a downward revision of China, adds to the fact demand won't be able to lead the market out of its price doldrums in a meaningful way.

Unless you want to generate some quick gains from the ongoing news reports of Russia and OPEC being ready to meet and work out a supply deal, I would completely ignore the meeting scenario being pushed by the media.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.