OK, Now OPEC Is Officially Dead

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Includes: BHI, BNO, BP, CVX, HAL, RDS.A, RDS.B, SLB, USO, XOM
by: Vladimir Zernov

Summary

The Doha meeting failed.

Key takeaways from the results of the Doha meeting.

Which oil stocks will benefit from the non-deal?

Besides epic works like "War and Peace" or "Anna Karenina", Leo Tolstoy wrote very short stories for kids. One such story is "The Liar". The plot of the story is simple - a shepherd boy is crying "Wolves! Wolves!" when there are no wolves around. When real wolves come, no one believes him anymore because he has lost the trust of his fellow peasants. Without any resistance, the wolves kill all the sheep.

OPEC countries followed the footsteps of the shepherd boy by pitching the production freeze to the investment public. Their plan worked, as aggressive PR of the meeting lifted the oil prices from the lows. Back in December 2015, I stated that OPEC was dysfunctional and oil had a serious chance to fall to $25 per barrel.

The thesis worked in momentum, and oil was really close to $25 - a price target that would have been laughed at just several years ago. Together with Russia, OPEC convinced the world that it was serious with production freeze talks. Now, the organization has shown the real value of its words. Will investors believe OPEC once again?

What happened?

The Saudis, who previously stated that they could add one million in daily production immediately, walked away from the deal. Not surprisingly, a $40-something oil environment is quite different from a $20-something oil environment for the kingdom. With oil in the current uptrend, Saudi Arabia was able to recall its political tensions with Iran, which previously defended its right to push oil production back to pre-sanctions level.

Perhaps, the Saudis decided that the meeting idea worked well, and oil prices will take care of themselves without intervention. The strike in Kuwait certainly helps mitigate the negative impact of the no-deal - as I'm writing this, oil futures are way off their lows. Also, the current market remains favorable for commodities as a group, and market participants will likely continue buying dips unless another bearish catalyst shows up.

We will probably never know the exact reasons behind the decision, and I won't put too much trust in participants' comments in the press. The next OPEC meeting will take place in Vienna on June 2, and I think there won't be as much hype around that meeting as this time.

Main takeaways from Doha meeting

I see two main takeaways from the results of the Doha meeting. The first one is that all oil producers are on their own, and we will continue to see increased competition. OPEC members will continue to hold meetings, but they will likely be more of a discussion forum rather than trend-setting events.

During this downturn, OPEC countries have shown their inability to act together, and I see no reasons why this will change in the future. Political rivalry between Iran and Saudi Arabia is too big. It also looks like decision-makers believe in the price-setting role of U.S. shale and prefer to wait for mass bankruptcies and production cuts in the U.S. rather than give their competitors a helping hand.

All in all, this means the cartel is not a cartel anymore. The oil market has become very competitive, which always puts pressure on prices. From this point of view, the outcome of the Doha meeting is bearish for oil prices.

However, the Doha results could also be interpreted as bullish. One could argue that Saudi Arabia is so confident in oil price recovery that it does not want to lose any ground to its rival Iran. This line of thinking may even provide a short-term rally for oil, if enough fund managers believe in the narrative.

I believe the outcome of the meeting will have a negative impact on oil prices if we look at a time horizon beyond a few days. Competition has always been beneficial for consumers, not producers. While oil will remain a politics-heavy commodity for the time being, supply and demand begin to play an increasingly important role for oil prices.

Impact on equities

The outcome of the Doha meeting is the additional uncertainty about the price of oil. Thus, the fear of missing out will continue to battle with the fear of loss in investors' minds. The usual winners in this case are the majors - Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX) and Royal Dutch Shell (NYSE: RDS.A). I've seen a number of arguments here on SA and elsewhere that these companies are overvalued. However, stocks rise not because they are undervalued, but because market participants buy them.

The luxury of betting on oil without having to worry each night whether your company just filed for bankruptcy is a price worth paying for many investors, both institutional and retail. I think there could be more upside in BP Plc (NYSE: BP), especially if its peers reach valuations which will be hard to justify even for most optimistic investors.

Big oilfield service companies like Schlumberger (NYSE: SLB) will have support just like big producers. Even the ever-failing deal between Halliburton (NYSE: HAL) and Baker Hughes (NYSE: BHI) did not put much pressure on either name.

More speculative names will continue to follow the ups and downs of the very volatile oil price. And most likely, the absence of the deal is a coup de grace for those companies that were struggling with low prices and large debt loads.

Bottom line

The current bullish market in commodities continues to show its strength, and oil is no exception. In other circumstances, the outcome of the Doha meeting would have literally crushed oil prices. However, the market will have to leave without the production freeze narrative, and will ultimately concentrate on supply and demand dynamics. With high inventories and hedging efforts from struggling producers, oil will have to find a really significant catalyst for another leg up.

Related ETFs: United States Oil (NYSE: USO), United States Brent Oil (NYSE: BNO).

Disclosure: I am/we are long BP.

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.