Saudi Arabia Obliterates Idea Of Agreeing To Oil Production Cut - Market Continues To Ignore Clear Statement

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Includes: OIL, USO
by: Gary Bourgeault

Summary

There will be no agreement to cut oil production.

Saudi Arabia and Iran have no interest in reducing supply - believe it.

Saudis reiterate they will continue to defend market share.

Oil prices will be determined by "supply and demand and by market forces.".

Why this has even been in the news cycle.

It looks like those jumping on the oil price bandwagon are going to get crushed in the near future as not only is there little likelihood there will be an agreement to freeze production, but hopes it would lead to a cut in production has been demolished by a statement from Saudi Arabia's foreign minister, who said the country has no interest whatsoever in cutting production.

Oddly, the market is acting as if this is an irrelevant assertion, instead holding onto the misguided idea of a production freeze, which in fact isn't an agreement at all, but simply a proposal for competitors to think about. Yet if you were to believe media reports, you would think it was a done deal. All Russia, Venezuela, Saudi Arabia and Qatar agreed to was if others came on board, they would be willing to keep production at current levels.

Even this is disingenuous because the production levels of Saudi Arabia and Russia are so high, it would be smaller producers that would take the hit, not them.

Another interesting aside is oil inventory in the U.S. once again climbed to a record level, but the market shrugged it off as if it was now a non-event.

What this tells me is the financial media are driving the narrative by giving the impression there is some type of breakthrough coming, when in fact nothing has changed. I've wrote about this in the recent past, where the idea of an agreement, not an agreement itself, will be used in an attempt to support oil prices. It's working for now, but it's going to get old quickly, and when the illusion dissipates, the price of oil will once again come crashing down.

source: Smico

Statement from Saudi Arabia should be believed

Saudi Arabia couldn't make it any clearer than this statement from foreign minister Adel al-Jubeir:

If other producers want to limit or agree to a freeze in terms of additional production, that may have an impact on the market, but Saudi Arabia is not prepared to cut production.

The only reason the proposed oil production freeze affected the price of oil was because of it eventually leading to a cut in production. Saudi Arabia has effectively taken that off the table. Iran already wasn't going to agree to a production freeze, and it's obvious it wouldn't seriously consider a production cut in light of the statement from the Saudis.

Investors should believe the statement and make adjustments to the investing strategy accordingly. I've been trying to convince investors for some time there is nothing to the idea of OPEC and non-OPEC members making a deal of any sort. Even the proposed production freeze never had a chance. It was only theater offered to convince some of the clueless it was legitimate. That way the price of oil would jump up as it did. While it's becoming increasingly obvious no production cuts will be made, there will continue to be media assertions to the contrary until they're totally ignored by the market.

Don't give them any credence or get confused by them. Completely believe the Saudis when they say they aren't going to make any production cuts.

Market forces

For some reason the market has decided to ignore statements the Saudis have made for a long time concerning allowing market forces to work the oil issue out. This was reiterated by Adel al-Jubeir, when he confirmed the price of oil will be determined by "supply and demand and by market forces." Again, I don't see how that can be interpreted in any other way than the clear way it was communicated.

One of the reasons I believe the thought of production cuts having potential to become a reality is from past statements made by Saudi Arabian officials, where it was said if competitors were all willing to cut production by 5 percent, it would do the same.

The problem is this was taken as a serious offer rather than the hyperbole it was. There was never a chance something like that would be agreed to, but the media ran with it, leading up to the situation we have today, where the market is all enamored with the potential for a deal, even after Saudi Arabia blasted the idea out of the water.

Keep repeating this to yourself: There will be no oil production cut deal.

Defending market share

Let's look at some other terminology used by Saudi Arabia. This time the phrase is it will defend its market share.

Adel al-Jubeir concluded, "... The kingdom of Saudi Arabia will protect its market share and we have said so."

Again, is there any way this can be misconstrued? I don't think so. Defending market share is only another way of saying it will keep the oil flowing. In my view it also suggests there was never a real chance there would be a production freeze. It also suggests even if there was a deal made, the Saudis and others, as has been the historical practice, would conveniently ignore it. Russia has done the same the last time there was an agreement put in place.

The point is defending market share is a market response. It's being forced to do this because of the emergence of the U.S. shale industry, and the future growth of shale at the global level. Nothing can change that - all that can happen is for competitors to slow the pace of shale growth.

Saudi Arabia has literally nothing to gain by lowering production. If it did so, the price of oil will jump, but its higher-cost competitors would immediately boost supply and take market share from Saudi Arabia. This is the new reality, and the Saudis will continue to pump oil, as will its OPEC competitors.

What's the impetus behind all of this?

The assumption may be at this time that oil investors understand what's going on here, but most don't, which is why so many are taking these latest media-driven stories as having a basis in reality. What is driving all of this isn't the general oil market, but how the current pressure on prices is devastating Venezuela, which is an economic basket case.

There's a reason Venezuela and Russia were at the meeting with Saudi Arabia. Russia was there because of it being a ally of sorts with Venezuela, and was obviously in a support role. Interestingly, China, which has offered aid to Venezuela in the past, was conspicuously absent from the meeting where the proposal to freeze oil production was put forth. While Russia and the Saudis have had pressure on their budgets and economies because of the plummeting oil price, they have the means to endure it for much longer than Venezuela, which is already at the end of its economic road. It's close to collapsing.

The price of oil would probably have to rise to about six times what it's trading at as I write to meet the budgetary requirements of Venezuela. It has already devalued its currency and raised the price of gasoline by over 6,000 percent; that translates to about 11 cents per gallon after the increase.

Venezuela has been the most vocal of the OPEC members concerning doing something to change the price of oil. The response from Saudi Arabia is basically this: you're on your own. Allowing market forces to dictate the outcomes means Venezuela is in for a long period of pain. It probably shouldn't have nationalized the oil sector years ago after the private sector invested millions into it.

The pressure to make some type of production cut deal has to be understood in light of Venezuela's current struggles. Saudi Arabia's response tells me they're tired of the pressure and are going to do what's best for Saudi Arabia. Many other OPEC members feel the same way about it.

Conclusion

Adding this all together, there can be no other conclusion than there will be no agreement to cut oil production. And since all major competitors agree on that, it tells me the price of oil is going to get crushed in the not-too-distant future, as the rally is based on nothing but vaporous innuendo that even those that could benefit from the narrative continuing on, have publicly rejected the idea.

Even the idea of a production freeze is also weak when considering there is no way Iran will be part of it. That means in the best-case scenario the major producers would continue to exceed demand at current production levels, while Iran adds up to 2 million more barrels per day to the market over the next couple of years. How is that a bullish outlook?

Based upon Saudi Arabia's comments on letting the market work this out, it means, the pace of growth of global oil demand, which has been downwardly revised for the next year, will drive the price of oil. If that's how it continues to play out, which is highly probable, it could take at least a couple of years before market forces start to rebalance the market. At that time there could be even more oil being added because countries like Argentina have been spending on exploration in their own shale deposits, which have proven to have more reserves than previously believed. That has brought the total recoverable shale oil in the world to about 419 billion barrels. There can be no doubt as exploration increases, that will continue to rise.

Investors can safely ignore the proposed production freeze, and especially the idea this will lead to a production cut agreement. It's not going to happen. Allowing Venezuela to crash and burn confirms there is absolutely no will by oil competitors to prop up the price of oil artificially. Invest accordingly.

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.