Will Lying And Cheating Sink An OPEC Deal?

| About: The United (USO)


The Algerian surprise put the price of oil at $50.

OPEC has a history of lying and cheating.

Will the Russians change history?

The U.S. election and the politics of energy.

The high odds play for crude oil- U.S. inventories help the cartel.

Crude oil has been strong lately. The price has remained above the $50 per barrel level on a combination of stock declines in the U.S. and the prospects for the upcoming OPEC meeting in Vienna on November 30.

Depending on OPEC to make a move that will cause the price of the energy commodity to move higher than the current price level amounts to a giant leap of faith. The cartel has done little, if anything, over recent years to inspire any trust in the group other. In fact, many experienced oil market participants will tell you that following OPEC statements is a fool's game as the cartel has resorted to spoofing oil prices. OPEC certainly has the element of surprise on its side these days because they have given the market no reason to believe anything that they say for decades. The history of lying and cheating is institutionalized when it comes to OPEC, and the question has become, why would that change now? In August, the price of nearby NYMEX crude oil futures fell to just below the $40 per barrel level. When OPEC and the Russians announced another get together in Algeria in September few paid any mind. After all, the last meeting in Doha, Qatar amounted to absolutely nothing.

The Algerian surprise put the price of oil at $50

When OPEC and the Russians sat down in Algeria, market expectations for anything other than pleasantries were almost non-existent. However, when the group emerged from the meeting news of a production freeze to take effect in November produced a mild surprise. We heard this before in the lead up to the Doha meeting, but problems arose when the Saudis would not agree to any freeze or output limits unless each member pledged to participate. With Iran continuing to claim that it is their sovereign right to sell as much oil as their heart desires, any hopes of coordinated action went up in smoke.

However, the meeting in Algeria was different. The Russians, led by Vladimir Putin, have done yeoman's work to convince the Saudis and Iranians that a deal would help each. Saudi financial reserves have been falling dramatically as the Kingdom has struggled to make it through the bear market in petroleum prices. Iran, fresh off the nuclear deal with the West which increased their reserves dramatically have not been selling their potential output for years due to sanctions. When those sanctions lifted, Iranian output was far from capacity production and they have claimed that any increases in production are a catch-up for years lost. Additionally, Saudi daily sales dwarf those of Iran so capitulation when it comes to allowing Iran to increase production is not a big deal for the Kingdom. The Russians have seemed to make lots of progress in the lead up to the Algerian meeting and during the get together as it appears that the bulk of any production cuts or freezes will come from the world's largest producers. In the wake of the meeting, Vladimir Putin himself told the world oil markets that Russia, although not a member of the cartel is also willing to do its part.

It seems like there is a deal but the attendees decided that they would wait for the November biannual meeting of the cartel, for final ratification of the deal. Of course, time could mean that there is plenty of time for things to go wrong. Meanwhile, the price of oil has been steadily increasing over recent weeks because of a combination of the Algerian news and declines in U.S. stockpiles. One of the questions that the market will continue to ask itself over the weeks leading up to the meeting in Vienna is why should we trust OPEC now?

OPEC has a history of lying and cheating

When the price of crude oil began to decline in June 2014 from over $107 per barrel on the nearby NYMEX futures contract, OPEC stood on the sidelines. At their fall meeting, as the price reached $75, the cartel told markets let it fall taking the position that a lower price would damage North American shale production and allow OPEC member nations to increase market share. However, the price continued to fall, and it was not until February of 2016 when the price reached the lowest level since 2003 at $26.05 per barrel that panic began to set in among OPEC members. The announcement of the meeting in Doha amounted to little more than a spoof to the market but it succeeded as the price of the energy commodity has not returned to the February lows and is now almost double the price.

When it comes to OPEC production quotas, freezes, and cuts over decades, the cartel has a long history of lying, cheating, and deception. For the longest time, However, when it became apparent to the market that total output was running above 32.5 million barrels each day, OPEC clarified their position. The ceiling, they said, was not a quota but a "recommended level" that could change over time. Additionally, the cartel has a history of lying about total reserves, inflating and deflating numbers to suit their needs and jawbone the price of the energy commodity higher. So, when OPEC members came out of the Algerian meeting all happy with an agreement the market dismissed their exuberance as another example of deception to cause the price of oil to rally.

Meanwhile, when the price of oil fell in February, there was panic among members. While the poorest members of the cartel; Venezuela, Ecuador, Nigeria, Angola and others were staring into an abyss of economic disaster, even the financially stronger the Gulf States watched as their reserves dwindled. In the volatile Middle East, countries like Saudi Arabia need oil revenue for social programs that pay off the citizenry and protect the power and hold the position of the Royal Family. An oil price that was over 75% lower than the mid-2014 price was not only a concern; it was a disaster. Another country suffering from the low price of the energy commodity was Russia. Additionally, Western sanctions after the annexation of Crimea put the Russians in a more precarious position compared with other oil producing countries. As the Putin government strengthened ties with Iran over recent years over protecting the Assad regime in Syria, low oil prices presented the opportunity to raise their profile with other OPEC countries.

Will the Russians change history?

The low oil price has been both a curse and a blessing for Russia. It has cost the nation tremendous amounts of revenue and has thrust the country into a deep recession. At the same time, it has created the opening for the Russian leader to take more of a leadership role on the world stage. Mr. Putin has raised his political capital with OPEC, showing up on the scene as a peacemaker between Saudi Arabia and Iran. If OPEC ratifies the Algerian agreement and there is a verifiable production cap and freeze at 32.5 million barrels per day on November 30, Putin will be able to take a victory lap, and he will emerge as a savior for many oil producing countries around the world. Russia and Saudi Arabia are the top two producers of petroleum in the world, with each producing more than 10 million barrels each day. The U.S. was climbing to challenge the two countries, but the fall in oil prices and high output costs caused North American production to fall as it became uneconomic.

A firm agreement in Vienna is far from a sure thing, and there is a lot that can go wrong over the next six weeks. Remember, the Saudis remain ensconced in a proxy war in Yemen with Iran and temperatures have been rising in the region over recent weeks. Missile attacks into Saudi territory have become the standard, and Iranian-backed rebels have even fired on U.S. warships in the area prompting a swift response as the U.S. took out some rebel missile defense shields.

While the Saudis remain close with the U.S., those relations have frayed over recent weeks as Congress passed a bill that allows 9/11 families to sue the Kingdom. President Obama vetoed the bill but Congress, for the first time, overrode his veto by a huge margin. Therefore, the Saudis are in a position where they may not be able to depend on the U.S. as they have in the past and cozying up to and cooperating with Mr. Putin is a smart strategy.

The U.S. election and the politics of energy

Before the OPEC meeting, the U.S. will elect its next President. On November 8 either Hillary Clinton or Donald Trump will become the forty-fifth U.S. President and the leader of the free world. Each candidate has a different orientation to the Saudis and the oil market. Clinton is likely to continue to be a friend to the Kingdom and given the Democratic platform; she could be a great friend indeed to OPEC. Increased energy regulations in the U.S. to protect the environment could cause the production cost for petroleum to rise and output to fall, achieving the initial goal for the Saudis, their partners in OPEC and the Russians of increasing global market share.

A Trump victory would likely present the opposite results, and the Republican has stated, on more than one occasion, that countries like Saudi Arabia, that depend on U.S. military aid and defense should pay a hefty price, and he intends to collect. Therefore, OPEC and the Saudis are likely praying for a Clinton victory on November 8. I find it odd that the Democrats are pointing fingers at the Russians for interference in the U.S. election as Clinton's policies are likely bullish for the price of oil. Perhaps Mr. Putin is hedging his bets all over the world if he is releasing emails, as the Democrats charge, to weaken the incoming President for his advantage if Clinton prevails in the election.

The high odds play for crude oil- U.S. inventories help the cartel

OPEC got lucky in the wake of Algeria, the stars lined up for the cartel and the Russians. A steady decline in U.S. stockpiles has caused the price of oil to increase slowly to above the $50 per barrel level.

Crude oil has climbed to oversold territory on the medium-term chart. Click to enlargeAs the weekly chart highlights, NYMEX nearby crude oil traded to the highest price since July 2015 on Wednesday, October 19 and the technical trend continues to be higher. Oil rallied after the API reported a surprise decline in stockpiles of 3.8 million barrels on Tuesday; the market expected a build of 2.4 million. On Wednesday, the EIA validated the API numbers with a 5.2 million barrel decline in stocks. It was stockpile numbers rather than the prospects for an OPEC deal with the Russians that sent oil to the highest price in over a year this week, but the Algerian deal certainly does not hurt the price of oil for the next six weeks. On Thursday, crude oil retreated on light volume as the U.S. dollar rallied to the highest level since March. A strong dollar tends to be bearish for all commodity prices as the dollar is the reserve currency of the world and the benchmark pricing mechanism for most raw materials. However, oil remained above the $50 level on the NYMEX December crude oil futures contract.

Oil has now reached a price level where any issues that cause the deal of fall apart on November 30 should result in a spike to the downside. We will soon find out if OPEC is lying, cheating, jawboning and engaging in deception once again or if the Russians have successfully figured out a way to bring the cartel together to finally do something constructive for the price of the energy commodity. One of the most important aspects of any deal will be the verification of any production caps. Meanwhile, expect the bid to stay in the oil market for the next six weeks, and the price should edge toward $55 per barrel if the inventory draw continues in the weeks ahead. I continue to believe that nearby NYMEX crude oil futures will remain in a range from $50 to $55 per barrel until November 30.

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