While the OPEC meeting tomorrow has captured lots of the headlines, it had been inventory reports in the United States that moved the price of the energy commodity over recent months. The fact is that NYMEX nearby crude oil prices have traded in a range of just under $40 per barrel to just over $50 per barrel since the middle of April. When inventories began to decline, according to the API and EIA in October, the price rose. When they moved higher once again in late October and early November the price of the energy commodity fell back towards the lows.
When oil fell to its lowest level since 2003 at $26.05 per barrel on February 11, the world's largest producers panicked. Oil revenues had been declining since June 2014 affecting the economies of the poorest members of the cartel, but the sub $30 per barrel price took a mighty toll on some of the world's largest and most influential oil producing nations. Saudi Arabia, the world leading producer, saw its cash reserves decline precipitously and Russia was also suffering under the weight of lower energy prices.
At a meeting in Doha, Qatar early this year the Russians attempted to position as a mediator when it comes to long-standing conflicts between some of the cartel members, namely the Saudis and the Iranians. The Doha meeting did not give birth to any cartel policy changes but it did spotlight Russia's willingness and dedication to working with OPEC to stabilize the price. The price of oil increased in the aftermath the Doha meeting despite the inability to create a concrete deal. Meanwhile, the Russian leader has been steadily increasing his visibility on the world stage over recent years. Vladimir Putin's interest in guiding OPEC is just one more example of an attempt to expand his influence.
The result of Wednesday's OPEC meeting will, in many ways, be a report card on Putin's ability to negotiate and influence policy in the Middle East. If OPEC can come to an agreement that is solid and verifiable it would be clear that the cartel was Putinized. Any deal would likely be more political than economic. However, with the meeting less than 24 hours away it looks like the chances of an accord have diminished.
The most important biannual meeting in years
OPEC was unable to come to any agreement at their June meeting to freeze or cut production after the strategy session in Doha. However, the cartel did state that the dialogue would continue. In September, another session with the Russians took place in Algeria and the word from that meeting was that the members moved closer to an agreement. However, the devil is always in the details when it comes to any production quotas.
The tenuous relationship between Iran and Saudi Arabia promised that no deal was possible without mediation from a party that both sides respected. Russia, as the second most influential oil producer in the world has the respect of the Saudis. The cooperation and alliance between Russia and Iran in Syria and throughout the Middle East has resulted in an atmosphere of trust. Therefore, there may be no better mediator in the world than the Putin government when it comes to getting a deal done tomorrow where give and take from all parties will be a necessity.
Iran has been consistent in stating they deserve an exemption from any production freeze or cuts given the sanctions on the nation before this year. Iran states that it is their sovereign right to increase output and it is likely that Russia accepts and advocates for that position. Meanwhile, other cartel members have also petitioned for an exemption. Iraq has stated that fighting ISIS has created an economic necessity for the nation to increase output in months ahead as they recapture territories previously held by the terrorist group.
As the daily chart of NYMEX January crude oil futures highlights, the price increased from the November 14 lows of $42.95 per barrel because of inventory builds to highs of $49.20 on November 22 on hopes for an OPEC freeze or cut. Additionally, open interest rose to the highest level in history$45 per barrel level, right in the middle of the trading range.
Tomorrow is perhaps the most important cartel meeting in years and the market remains dubious. Late last week, it appeared that an agreement would be more difficult given the competing interest of the membership and the Saudis intransigence when it comes to shouldering the lion's share of production cuts necessary to make any deal work. The Saudis canceled a technical session to discuss a deal with non-OPEC members including Russia scheduled for Monday stating that the oil market would rebalance itself in 2017 even if producers did not intervene. The Saudi oil minister appeared to be managing market expectations going into the meeting. Khalid Al- Falih said that he could justify keeping current production levels as a production cut which may not be necessary as demand for oil will increase in the coming year. Today, the Russians said that they have no plans to meet with OPEC in Vienna on Tuesday but they stand prepared to talk if the group reaches a consensus.
We have seen lots of volatility in the oil market as we head into tomorrow's meeting with the price on NYMEX trading in a range from $45 to $49 per barrel over recent sessions and it appears we will go into the gathering at the low end of the range. The current level of open interest tells me that plenty of speculative traders are betting that there will be no deal in Vienna. The metric remains above the 2.01 million contract level and if history is a guide many of those positions are shorts.
Past gatherings have been flops
OPEC has not been able to get their act together since the price of oil dropped from over $107 per barrel in June 2014. While oil has recovered from last February's lows, the price remains at less than half the level it was two and one-half years ago. As the price of oil fell, OPEC decided to increase output. The initial strategy advocated by Saudi Arabia was to flood the market with oil making high cost North American shale production uneconomic. The strategy failed because even though the number of rigs in operation declined, oil output in the U.S. did not decrease at a commensurate rate. New technology helped to lower production costs as the world's third-largest producer of the energy commodity adapted to lower prices.
OPEC and non-OPEC production have been on the rise over recent years. While China has been adding oil to their strategic petroleum reserves as the price fell, supply has overwhelmed demand and it appears that unless OPEC can get their act together, lower prices are likely. Meanwhile, any deal would be a first for the cartel in recent times and the market is betting against any accord.
At each of the biannual meeting since 2014, the market has held its breath for some supportive action from the cartel. However, each time OPEC disappointed oil bulls. This time, their backs are against the wall as they convene, there are three reasons why inaction by the cartel could mean oil will break below the $40 level.
The cartel's back is against the wall
The first reason that OPEC finds its back against the wall is history, which tends to repeat itself. After many of the past meetings that resulted in no action to fulfill the cartel's mission to stabilize the oil price, the membership knows that the market reaction will be to sell causing the price to fall. It was the unsuccessful gathering of the cartel one year ago that led oil to trade to the lowest price since 2003.
Another reason for concern amongst the membership is the rise of the dollar. The dollar is the reserve currency of the world and the benchmark pricing mechanism for most commodities, including oil. Click to enlarge Source: CQG
As the weekly chart of the dollar index highlights, the dollar broke out to the upside and is currently trading at the highest level since 2003 in the wake of the U.S. election. A higher dollar tends to be bearish for commodity prices given the historical inverse price relationship between the U.S. currency and raw material prices.
Finally, the political fallout from the U.S. Presidential election is not only a sign but a virtual guaranty that American oil production will increase in the months and years ahead. President-elect Trump ran on a platform of strategic energy independence and fewer regulations on the oil patch. Less regulation will mean that production cost in the U.S. will decline and output will increase in the years ahead. The U.S. is the third largest producer of crude oil in the world.
Politics and economics have put OPEC's back against a wall. The involvement of the Russian President who has personally expressed his support of a deal that will stabilize oil and stated that Russia would do its part to make an agreement happen is another pressure on the oil ministers at this time.
The Saudis must capitulate for a deal to occur
If a deal occurs tomorrow, it will be the result of lots of horse trading behind the scenes between the Russians and Saudis. The overriding issue for Saudi Arabia is that they require the participation of all members of the cartel for any deal. At the eleventh hour Iran and Iraq have stood up to the Saudis publicly. The Saudis told Iran they need to cap output at 3.707 million barrels per day and Tehran offered 3.975 and both side remain with their heels dug in going into the session. Iraq has also been fighting for the last barrel with the Saudis. However, the reality of a deal will hinge on Saudi flexibility. With some 10.5 million barrels of output each day, Saudi Arabia is the 800-pound gorilla in the cartel and a deal hinges on their capitulation.
Meanwhile, the Putin government is exerting pressure on the Kingdom for two reasons. First, a higher oil price is in the strategic interest of Russia. Second, and perhaps more importantly, a deal will vault Mr. Putin to the top echelons of diplomacy in the world. However, to get to that level, Mr. Putin will need cooperation from the Saudi government.
Traditionally, the Saudis closest ally in the world has been the United States. However, the Iran non-nuclear proliferation deal of 2016 and a vote in Congress to allow American citizens to sue the Kingdom over the September 11 terrorist attack has created political strains. Moreover, the incoming President has repeatedly said that U.S. military protection of Saudi Arabia will come at a hefty financial price in the future. With Iran's power in the region on the rise, the Saudi Kingdom needs more friends in the world and Russia could play an important role of containing the theocracy's antipathy towards the Saudi Royal family. Russia is in an excellent position to do some behind the scenes arm twisting at the final hour.
Oil holds its breath for Wednesday November 30
Crude oil is perhaps the most important political commodity in the world. Production policy is on trial this week in Vienna and the verdict is coming tomorrow.
While the world holds its breath for OPEC to announce an agreement or no deal, the ramifications of the decision will reverberate through markets around the world like a tsunami. Any deal will depend on details. There will be compliance issues with any agreement as OPEC member have a long history of flexibility or deviating from stated goals. As an example, the quota of cartel output morphed from a ceiling to a recommended and flexible level of production as the price of oil fell. Eventually the cartel totally abandoned any notion of a ceiling on output. However, any deal will likely keep the bid in the energy commodity as many speculators are betting on no deal at all and they will need to cover short positions.
If the Saudi minister was telling the truth this past weekend, Iran and Iraq are standing firm, and there is no agreement other than a statement that says that the interested parties will keep talking and discussions are ongoing, expect the price of oil to break down below the $40 per barrel level quickly. In either case, I am looking at the OPEC meeting as a referendum on the political influence of Russia and Vladimir Putin. Mr. Putin has invested a great deal of political capital in the success of the Vienna meeting and resulting agreement. His star will rise if OPEC surprises the market with a deal. After all getting the members of the cartel to agree on anything would be a miracle. If there is no deal, Putin may keep on trying but it will be a sign that the Russian leader does not have the influence and control in the region that he has attempted to achieve. For me, the question is will the Russians leave their stamp on OPEC tomorrow or not? If OPEC is Putinized, it could have important consequences for the price of oil as well as for the political power base in the Middle East for years to come.
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