Iran Destroys Oil Freeze: What's Next?

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Includes: BNO, BOIL, DBE, DBO, DCNG, DGAZ, DNO, DTO, DWTI, FUE, GAZ, GRN, JJE, KOLD, OIL, OLEM, OLO, ONG, RJN, SCO, SZO, TONS, UBN, UCO, UGA, UGAZ, UHN, UNG, UNL, USL, USO, UWTI
by: Daniel Jones

Summary

Unhappy news broke on April 17th that OPEC and non-OPEC nations failed to reach an agreement pertaining to an oil output freeze.

The main reason appears to be Iran, which failed to show up and communicate about the issue.

This appears to be a major negative for investors in this space and I expect an oil price decline but are things really that bad?

With oil production already falling and a freeze expected to do little, it's probable that any large downturn in oil prices will be unwarranted.

As of the time of this writing, no public data was available to reflect what kind of action should be expected in the oil price arena but I would imagine that the trend for investors is looking negative at the moment. This is because, on April 17th, news broke that a meeting between OPEC nations (minus Iran) and some non-OPEC nations failed to end in an agreement between parties to freeze oil production at January levels. In what follows, I will dig into the data and suggest what this likely means for investors in the United States Oil ETF (NYSEARCA:USO) and other oil-related investments.

The meeting failed

According to recent reports, a meeting between OPEC and non-OPEC nations representing about 73% of global oil production ended in no move toward a resolution of the oil glut. Previously, many had expected and hoped (myself included) that a deal between these parties would have acted as a step in the right direction that would ultimately lead to a cut. While this expectation is still alive down the road, however, today is not that day.

The reason behind the failed talks comes down largely to tensions between Saudi Arabia and Iran. In the past, Saudi Arabia had been open to action but not if Iran decided not to participate. Having just come out of a tough-sanction environment, Iran has placed a great deal of emphasis on trying to increase its output from 2.8 million barrels per day to around 4 million per day to bring it back to pre-sanction levels. The single largest contributor to these failed talks was likely the nation's choice to send a representative, not their oil minister, Bijan Namdar Zangeneh, a move signaling that Iran is serious about getting back up to pre-sanction levels.

What should investors expect?

As a result of this, it's likely that oil prices will take a beating near-term and investors should probably be prepared for that. Having said that, though, I do not believe such a move is warranted when you look at the fundamentals. The reason behind this is three-fold. For starters, the market had assumed, based on the rhetoric coming from Iran, that they will continue to increase output for a while. Second, many analysts have made the observation that even a freeze, whereby OPEC (excluding Iran) and certain non-OPEC nations would keep output no higher than it was in January of this year, would not do anything to solve the glut but would, instead, ensure that the glut does not grow meaningfully larger. In fact, the real value in my mind was more along the lines that a freeze could (and probably would) lead to an eventual cut.

Both of these issues are important to consider when weighing what the effects of this failed meeting should be compared to what they will end up being. The third reason, though, is what's most important; an agreement between OPEC and non-OPEC nations might actually lead to higher output (again, excluding the impact from Iran). The reason boils down to what happened during the first quarter of this year. According to data provided by the IEA (International Energy Agency), total oil production has been declining worldwide.

Click to enlarge

In the table above, you can see what has happened between January and March of this year. In January, global oil production was estimated to stand at 96.68 million barrels per day. By March, this had fallen to 96.10 million barrels per day, a decline of 0.58 million barrels per day. Of this, approximately 0.23 million barrels per day can be chalked up to OPEC, driven by outages in countries like Nigeria, Iraq, and the UAE (United Arab Emirates) but somewhat offset by higher production in Iran, which analysts believe could hit 3.5 million barrels per day by the end of this year. Some may say that outages are temporary and that may be true, but with conflict throughout some nations caused by extremist groups (especially ISIS), there's no guarantee what to expect.

Outside of OPEC, though, we are still seeing oil production drop so far this year. Using data from the EIA, it seems as though domestic oil production has dropped by around 0.20 million barrels per day and the significant drop in rig count will realistically lead to this drop growing throughout the year. Even outside of the U.S., though, production is down about 0.15 million barrels per day through March, with places like the North Sea and Mexico likely leading the way. What all of this means is that, even without a deal between OPEC and non-OPEC nations, it's highly probable that the market picture will continue to improve, especially after news broke that Saudi Arabia and Russia are planning to freeze their output together even if Iran does not.

Takeaway

At this moment, many investors (myself included) are very unhappy by the news coming from Doha, Qatar. Certainly, it's likely that this will be seen as a net negative for oil and it will probably push prices down a bit. On the other hand, we need to be cognizant of the fact that, not only is global demand rising (albeit slowly), but that global output is falling, led in large part by the U.S. and, for the moment, OPEC. Ultimately, I do expect for Iran to increase their own production and I'd imagine that other OPEC members may see some increase in their own but I am confident that the current supply picture is still going to improve even without a deal (though I do expect an eventual deal).

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.