source: Stock Photo
It's increasingly clear as the date for the meeting between major OPEC and non-OPEC producers approaches, there is as much volatility between competitors as there is in the price of oil.
That has caused a lot of conflicting comments from participants in the media, which has generated a lot of doubt concerning whether or not there will be a production freeze deal reached, and in some cases, whether or not the meeting take place, as one Russian official expressed doubts over.
Where the major problem lies is in regard to efficiency differences between various countries, where some are content to allow the market to rebalance the supply and demand picture, such as Saudi Arabia, and others are in full panic mode, like Venezuela, which is in serious fiscal trouble because of high costs of production and heavy reliance on oil revenue for its budget.
Many of the major producers also hand out perks to their citizens, which they no longer can afford to do at prior levels. They know they have to ease up on their handouts, but they are trying to do so at a pace slow enough not to stir up their populations, which would lead to significant unrest.
This is a major reason so many conflicting comments are made to the media, as Saudi Arabia has obviously lost control of its leadership position in OPEC and every country is primarily looking at their own interests first. That includes non-OPEC member Russia.
Confusion and contradictions concerning production freeze
The market has received so many mixed signals from various countries getting together to discuss a production freeze, it has only added to the doubts on there being any unity among the countries that would allow for a deal.
For example, Russia has insinuated there are doubts whether there will be a meeting or not; Kuwait in the past said it won't participate unless Iran agrees to freeze production, and recently said the complete opposite; with Iran repeatedly saying it will never agree to a freeze, now a provision to allow them to continue production is being offered; for a long time the Saudis said they want the market to rebalance itself, but is now open to at least meeting to discuss a freeze; some media reports implied Saudi Arabia would agree to an Iran exception, yet has consistently said it won't freeze if Iran and other major producers don't - it reiterated that stance recently. I could go on with this list, but you get the point.
There are a couple of reasons these conflicting reports and assertions are being made. First, most producers that have had it good for so long are in panic mode. Some are trying to pressure their peers to take steps beneficial to them, even if it isn't in others' best interests. This is part of the inconsistency in reports. It seems they're trying to create a self-fulfilling prophecy by throwing proclamations out and seeing if they stick.
Second, it's also apparent the former chain of command or hierarchical structure has fallen apart. In other words, a lot of what is being said is either a personal opinion of the individual, or possibly a small group wanting a specific direction for their respective countries. This is why when something is said, those in leadership positions over them will say something different. That means it isn't being vetted through official channels.
At one time I thought this was being done on purpose to confuse the market in order to bring it to a place of being paralyzed or brought into inaction, which would possibly keep the price of oil more stable. But the different remarks were all over the place and have had little coherence, which brought me to the conclusion a lot of people are off the reservation in regard to going through official channels.
In other words, there are some things being said to manipulate what direction the market should take - those things are being approved of by those in authority. Other things are obviously the personal opinion of those communicating with the media, which has produced the state of confusion and doubt concerning a production freeze.
Saudi Arabia and the balkanization of OPEC
Related to the above is the role of Saudi Arabia in the global oil market and OPEC. There can be no doubt the emergence of the shale industry has disrupted the power it used to have to influence the price of oil, and is struggling itself to deal with this major market disruption.
Within that vacuum of power has risen what I call the balkanization of OPEC. There has always been an element of independence in the cartel, even though it attempted to present a united front to the world. But over the last couple of years it's easily apparent it has lost a lot of its power to drive the direction of OPEC, and that is seen by it being reluctantly dragged to the meeting to discuss a production freeze, even though it clearly stated it won't participate in a freeze unless Iran does.
What is driving this, besides the shale revolution, is the fact many of these countries aren't entrepreneurial, and when the price of oil had been high, the weaknesses in efficiencies and costs weren't readily apparent. The low price of oil has exposed their weak business practices, and as a result, those competitors are trying to push their peers into driving up the price of oil to overcome their inefficiencies and high costs.
Instead of doing what some American shale producers did, which was to scramble to cut costs and improve productivity, they kept on doing business as usual, and now want the rest of the major producers in the world to offset that.
This is not only why there are different signals from different countries, but why there is a quiet but visible rejection of Saudi Arabia's call for the market to rebalance the market over time. It's also why there's very little chance of a meaningful agreement to freeze oil production, even if there is a show deal made for media consumption.
Why it's in the best interest of the industry for oil to stay lower longer
Calls for steps to be taken to support the price of oil are misguided, as it will only prolong the pain needed by the industry to right itself after the introduction of shale supply to the market.
If the price of oil does reach levels in the second quarter some are projecting, it would allow weak shale producers to return to the market, saving them from their lack of being able to compete against stronger competitors, which would once again flood the market with excessive supply.
Even now the improved efficiencies of quality shale producers has allowed for them to endure much longer than everyone believed. To reward the weaker competitors with longer life only suspends the inevitable, rather than allowing the market to reward the better-run companies.
Why that's so is because the price of oil won't be approaching past levels for a long time - if ever. To give companies that should go out of business longevity past their performance level, is to further extend the period of adjustment the market must make in order to sustainably rebalance and find the new price range the sector will operate in. Anything upsetting the process will keep the waters murky. This is why Saudi Arabia has rightly called for the market to rebalance on its own. The idea of using tactics to extend the life of a company in hopes of prices returning to past levels is a fallacy.
The oil sector needs a good cleansing after the shale disruption, and until that is allowed to happen there will be a continual volatile response to a market no longer being driven by fundamentals but by dubious interventions that aren't sustainable.
Stronger OPEC and non-OPEC members aren't interested in propping up internal or external competitors, while they do little to change how the operate. They want the price of oil to be supported without taking the steps to run operations more streamlined and in the case of countries, reduce government expenditures to line up with market realities.
Since most of that is driven by ideology, it's hard to break through that mindset to have governments do what is needed to be done to operate under a smaller budget. They don't want to lose face even though they are no other options. Saudi Arabia knows this and is taking the steps to deal with a long-term low-price oil environment. Others that have positioned themselves as the providers of the people, such as Venezuela, face a potential loss of confidence that will change the political landscape for years. This is the impetus behind irrational push to freeze production, based upon the wrong assumption this is just another supply cycle being dealt with. It isn't.
While I find the production freeze noise irrelevant, it will be interesting under these unique conditions to see how it all plays out. Investors shouldn't price anything into the meeting unless they're trying to make a quick gain on the inevitable upward price movement as the meeting date approaches. That of course assumes the meeting takes place at all.
OPEC itself is falling apart, and is only an entity in name. Saudi Arabia has lost authority because the cartel itself has lost control over the price of oil, with the exception of the low end of the price. All it can do is keep production levels high in order to slow down the shale industry. That's obviously limited because of the high operational costs of many OPEC members. It can only keep production levels high for a limited period of time.
As for individual shale companies, what to look for is how strong their balance sheets are and the core assets they have to generate future growth. Having some non-core assets would also be valuable in case oil prices remain subdued longer than expected. Some have already employed secondary offerings to raise capital.
Concerning the proposed production freeze, some shale producers will win either way. Either the majority of companies will win if the market rewards a deal with a big surge in the price of oil, or if the freeze doesn't materialize or it's obvious it's a show deal, the quality shale producers will be rewarded by the removal of competitors from the American market.
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.