Is OPEC Output Deal Too Good To Be True?

| About: The United (USO)

Summary

OPEC's deal may be too good to be true.

Too close to mirroring all skepticism - appears to be made for media consumption.

Implementation strategy by Russia not likely to reduce supply anytime soon.

Indonesia leaves OPEC in order to produce oil at self-determined level.

Self-monitoring like fox watching the hen house.

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Source: Stock Photo

I continue to be skeptical about the announced production cut deal with OPEC, Russia and other non-OPEC countries.

One thing that is a positive is the cartel did hold to its initial goal of cutting production by 1.2 million barrels per day. That, at least, was based upon internal debate and considerations as to what they believed needed to be done in order to support the price of oil - at least in the short term.

What does concern me is the rest of the deal is the result of responses by the market in various matters, which the cartel and others addressed as negotiations continued on - all of which was associated with it being considered legitimate or not.

Another issue is everything is tied up too nicely for me to feel comfortable. It's obvious that a lot of the alleged internal strife was manufactured for the media, to give the appearance of uncertainty right up to the last moment. I've proposed that as a possible scenario in a prior article, and believe it played out that way.

The reason for that was to give the price of oil a nice boost. If it looked like everyone was playing nice, the market would have been less apprehensive and more likely to have settled in and accepted the deal as being done. Giving the appearance of uncertainty resulted in headlines and news reports suggesting the deal was secured in the last moments of the deal. In other words, a lot of this was theater.

Why that's important is that theater has brought about a deal, in my mind, that is just too good to be true. Out of nowhere, we're to believe everyone has got on board and will adhere to all the announced terms of the deal.

Keep in mind that all this is only an announced deal. There have been details included in the deal - one of the things the market required to give it at least the semblance of being legitimate. But there is still the lack of belief in how the participants in the alleged cut will prove they are adhering to their expected part in it.

Self-monitoring the deal

It has been reported that Kuwait, Venezuela and Algeria have agreed to watch over the various countries that made an agreement to make an oil production cut. The problem there is that's not much different than asking the fox to watch the hen house. Who is going to watch the monitors is what the real question is.

In other words, OPEC and Russia, in particular, have been notoriously resistant to observing terms of a deal, and even if the members above were to be able to accurately monitor OPEC, they're not going to be allowed to do the same with Russia and others outside of OPEC.

For that reason, once the hoopla subsides the price of oil will without a doubt pull back, while the market waits to be convinced and persuaded that this time it is different.

The only thing I see that will convince the market will be if we start to see inventory levels around the world drawn down significantly on a consistent basis. The market isn't likely to believe any numbers coming from self-monitoring, and will wait for data it believes and trusts in as being more accurate.

Russian compliance and implementation

The early news coming out after the announcement of the deal is that Russia may take a gradual strategy in implementing the cut. If that's how it plays out, it would mean it could take as long as three to four months before the effects of a Russian cut, as it relates to the promised 300,000 per day, to be in force.

That means by the time it were to happen, it would in reality only participate fully in the agreement for about two months. If the agreement were to be extended, it could have a more important impact on supporting oil, but for now, I don't see this being the case.

Russia is going to get together with other countries making the cuts in the near future, and we will hopefully get a clearer picture of the steps it's going to take and how soon they'll be implemented.

As it stands now, it appears it will be done incrementally, rather than all at once.

Indonesia leaves OPEC

The financial media has largely ignored the fact Indonesia has left OPEC because it wants to determine for itself at what level it will produce oil. Even though it's not a huge player, it does mean other participants in the cut will have to bear its part. It also means Indonesia has plans to increase production.

I see Indonesia as probably being the most honest of those negotiating to make the deal happen. It's simply saying it will continue to produce at whatever level it wants. The others could be easily saying they're willing to cut, and as in the past, simply continue pumping at whatever is in their own self-interests.

I see that as what will be most likely to happen; although there will be some nominal cuts to at least the appearance there is some substance to the deal.

In and of itself this isn't a big deal, but when combined with the continuing growth in output from U.S. shale producers, it does make a difference in market supply.

Conclusion

My major problem with this deal isn't the deal itself, as far as the number goes. It's that it looks like the cartel and Russia have overreached to the point of suspending belief as to it being based on any reality.

I expect there to be some cuts made, but in no way anticipate full compliance going forward.

We'll probably hear some more on various ways each country crucial to the deal will make the cuts, with it probably pointing to being nothing more than an excuse to keep production levels high.

Finally, after all the record or near-record high production levels, what has this deal done - even if it is implemented - much different than production was just six months ago or so?

Also, after Saudi Arabia had its domestic demand shrink by about 400,000 barrels per day, this deal allows it to cut less than 100,000 barrels per day from that total; meaning from exports. It may be making out better than the rest of those making cuts. What happens when the warm weather comes and significant cuts in exports face it?

This deal, as it is now, looks good on the surface. I expect it to be much less effective than the market believes. As mentioned, it does appear to be too good to be true. And when that is part of the thought process concerning something, it usually means it is.

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.