Crude Oil: OPEC Gets Ready To Meet With A Reactive Agenda

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A bounce in oil - as expected.

U.S. production of oil will increase.

OPEC meets next week. Backs against the wall.

Russia doing everything it can to foster a deal.

What's in store for the oil market on December 1?

Next week, the Oil Ministers of OPEC will gather in Vienna, Austria, for their biannual meeting with hopes of putting some meat on the bone of a deal discussed in Algeria in September. Russia, the second biggest petroleum producer in the world, has taken the lead role in bringing together the competing interests within the cartel throughout 2016.

The Russians have stood in between Saudi Arabia, the world's leading producer, and Iran. The sworn enemies have not been able to agree on many issues over recent years and Russian President Vladimir Putin has taken the position as a therapist when it comes to the two nations. A higher and stable petroleum price is in the best interest of the cartel and Russians but the oil market has been dubious that the sides can put aside their difference and honor the Algerian accord.

In the wake of the Algerian accord, oil inventories in the United States began to fall. The API and EIA reported some significant declines through September and October leading the oil price to appreciate to highs of $52.74 per barrel on the now active month January NYMEX crude oil futures contract. The rise of the price of oil was more a function of inventories than the Algerian agreement to cut or freeze production. When stockpiles once again rose over recent weeks, the price of the energy commodity fell to lows of $42.95 on November 14. Many trend-following traders and those who expressed serious doubt that OPEC would be able to come to any agreement on November 30 sold crude oil, and many took short positions. Open interest, the total number of long and short positions in NYMEX crude oil futures, rose to the highest level in history at over 2.07 million contracts on November 11. The overwhelming number of speculative shorts likely caused the bottom in crude oil. On November 15, in an article on Seeking Alpha entitled, Crude Oil- This Market Is Too Short, I explained why I thought oil would rally into the OPEC meeting because of the uncertainty created by the potential of some action on the part of the world's leading oil producers. However, the factor that made me most bullish was the record high level of open interest which led me to believe that the market got itself too short.

A bounce in oil- As expected

Crude oil spent very little time below the $43 per barrel level on November 14. Source: CQG

As the daily chart of January NYMEX crude oil futures highlights, while it traded to lows of $42.95 on November 14 the energy commodity closed the session at $44.29. The very next day, oil futures continued their ascent, trading to a high of $46.70 and closing close to the highs and above the $46 per barrel level. Oil has continued to recover, trading to a high of $49.20 on Tuesday, November 22. The slow stochastic, a momentum indicator, now indicates an uptrend. Open interest declined to the 1.97 million contract level, an indication that some of the speculative shorts closed risk positions when NYMEX futures rejected lows and now that the OPEC meeting will take place next week but it still remains at a high level. The rise in open interest to a record high was a sign that oil futures would run out of downside steam but many of the reasons why fundamentalist bears were so willing to short the energy commodity remain intact even though the price has increased.

U.S. production of oil will increase

The election of Donald J. Trump as the 45th President of the United States has significant ramifications for the global oil market. President-elect Trump ran on a platform that included energy independence for the United States and fewer regulations that will encourage production. Fewer rules and regulations will lower the production cost of oil, natural gas and even coal in the U.S. When it comes to crude oil production, the U.S. has the world's third-largest output and its annual production level is not that far from Russia's and Saudi Arabia's.

President-elect Trump's platform and promise to the American people is that he will put the United States first. Given the incoming President will have the support of both the House of Representatives and the Senate when he takes office on January 20, oil production in the U.S. will likely increase over the months and years ahead. One of the major targets of OPEC policy to increase production since 2015 was to push the price so low that U.S. shale production would fall and the cartel would increase their market share around the world, causing prices to eventually rebound. However, that strategy backfired when U.S. production did not fall quite as much as the cartel would have liked and the price of oil remained under pressure. The oil cartel had realized that their plan to benefit from a decline in U.S. shale output was not working when they agreed to cut or freeze production to stabilize the price in September. However, when they got together in Algeria, the conventional wisdom was that Hillary Clinton would be the next leader of the United States and energy policy and regulations would remain unchanged. The surprising election result has caused problems for other oil producers around the world and it has put the cartel in a position where their backs are now against a wall. They must come to some agreement or the price of oil could fall sharply once again. Meanwhile, the number of rigs in operation in the U.S. continues to rise, up another 19 last week to a total of 471, according to Baker Hughes.

OPEC meets next week- Backs against the wall

As the oil ministers convene in Vienna, the energy commodity that they will focus on has a lot of things going against it. They face a market where U.S. production is likely to increase in an environment of fewer regulations. OPEC faces a global market that does not believe the cartel can agree to a production cut or freeze that is verifiable and will result in less oil flowing from member nations. The cartel also faces a dollar that has broken out to the upside since the U.S. election. Source: CQG

As the monthly chart of the U.S. dollar index highlight, the dollar moved to the upside in a technical bullish breakout following the November 8 election. The dollar traded to highs of 101.54 last Friday, above the previous high of 100.60 and at the highest level since 2003. The dollar is the reserve currency of the world and is the benchmark pricing mechanism for most commodities around the world and oil is no exception. There tends to be an inverse relationship between the prices of raw materials and the dollar. Therefore, the higher dollar is a bearish factor for the price of crude oil.

OPEC nations want a higher price for oil. The poor member nations like Nigeria, Venezuela and others have been experiencing severe economic hardship with oil still at less than half the price it was in June 2014. Even the wealthier member nations have suffered under the weight of a falling oil price with Saudi Arabia and the Gulf States bleeding reserves because of the decline in oil revenues. If the members of the cartel cannot agree on the terms of a deal that will stabilize the price of the energy commodity, the chances are that it will head lower. In February 2016, nearby crude oil futures fell to the lowest price since 2003 at $26.05 per barrel and none of the producers want to see a return to a price anywhere near that level. With so many factors for oil looking negative, OPEC has little choice but to come to some agreement. Their proactive strategy of flooding the market with oil failed and now the cartel must become reactive to protect against economic carnage.

While it is in the best interest of all of the OPEC members to agree on something that will cause oil to move to the $50 per barrel level or higher, the Russian economy could also do with a shot of economic stimulus that a higher crude oil price would provide.

Russia doing everything it can to foster a deal

In many ways, Russia is in the same economic boat as many of the oil producing nations it has been trying to help throughout 2016. Russian assistance began with a meeting in Doha earlier this year when oil was below $30 per barrel. Russia has established an alliance with Iran when it comes to the ongoing crisis in Syria. When the Putin government suffered under sanctions in the wake of the annexation of Crimea, they found a comrade-in-arms in Iran.

However, Russia also has made overtures to Saudi Arabia and other oil producing nations around the world and the Russian leader has been acting as a mediator within the cartel even though they are not officially a member of the Organization of Petroleum Exporting Countries. After attending the Asia-Pacific Economic Cooperation Summit in Lima, Peru, last weekend, President Putin told reporters, " Whether an agreement will be reached, I can't say 100 percent, but there's a strong likelihood that it will be achieved. The main contradictions with OPEC, if they're not yet eliminated, can be eliminated." Putin went on to go one step further than he has in past statement adding, "There's no difficulty for us to freeze production," an indication that Russia is willing to do their part to get a deal done. There are members of the cartel that will insist on an exemption from a production freeze or cut, for example Iran has stated that it is their sovereign right to increase oil output because of the many years of sanctions on the country. Therefore, any deal will depend on the two largest producers, Russia and Saudi Arabia, shouldering the bulk of the changes in output necessary to make a deal a reality on November 30. It now appears that Russia is doing everything they can to foster a deal and there is probably lots of arm twisting going on when it comes to Saudi Arabia. After all, if there is no deal at the Vienna meeting, the price of the energy commodity will likely move much lower and the Saudis cannot afford that to happen.

What is in store for the oil market on December 1?

The Saudis have announced their intention to sell a percentage of Aramco (ARMCO), the state oil company, in 2017 or 2018. If the price of oil plunges in the wake of a cartel meeting where there is once again no deal, the future proceeds from any sale of Aramco will suffer. Therefore, the Saudis may have to play ball and cut output to make a deal happen next week.

The bottom line is that November 30 is a line in the sand for the price of oil. If there is no deal, the price of the energy commodity is going lower, perhaps a lot lower. However, a deal that the market believes can be a framework for a production quota at a lower than the current record level will cause a continuation of the price recovery in 2017. It may be heads I win tails you lose for Saudi Arabia as they travel to Vienna next week. I'm betting that there will be a deal because Russia wants it to happen and that means those still sitting with short positions could wind up scrambling to cover at the beginning of December. Vladimir Putin may have injected a proactive agenda into a cartel that is accustomed to reactive policy or no policy change at all over recent years. We will find out on November 30 and while the vast majority of market participants remain dubious about OPEC's ability to do anything to stabilize the price, Mr. Putin may be the one reason they will.

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