The battle for market share in today’s oil market and the internal battle within OPEC is much like the 1970’s card game Top Trumps in which the aim of the game was to compare the numerical values on your opponents cards and then to try and trump and win their cards. The winner eventually declared when he or she had taken all the other players cards (more on that later).
But first, perhaps it shouldn’t have been a surprise.
Just as the drop in oil prices completely wiped out all the gains since mid-August headlines reported that the cartel-like organisation was embarking on one final diplomatic push to secure a cut in oil production. Just two weeks before the group’s meeting in Vienna, Saudi Arabia, Iraq and Iran are still at odds over how to share production cuts.
It was back on 11th August that Saudi’s Energy Minister first suggested that the group would meet to discuss possible actions to stabilise the oil market. Ever since then whenever oil prices fell sharply on fears that the group would not live up to their promises and short positions in the futures market were at their most extreme, one or another OPEC representative would intervene to help buoy the market. And yesterday was no different.
See this analysis from Morgan Stanley prior to the latest round of verbal intervention.
OPEC can still spook markets. Although OPEC’s actions have not matched its words (i.e. promoting the need for production restraint while quietly growing production), the cartel has become adept at talking up declining markets. The group has repeatedly made bullish announcements about OPEC intervention during periods of low liquidity (e.g. US holidays), and whenever short positions become large. Despite the fact that many investors are skeptical of OPEC’s ability to change the outlook, prices still move on these headlines. Investors have proven that they are not willing to press short positions against OPEC, even if the odds of intervention are low. In essence, this is similar to the old adage of “Don’t Fight the Fed.”
We’ve highlighted before that you can only cry wolf so many times before the market loses interest. Surely they are going to have to follow through on their promises now or face losing all credibility while oil prices plunge?
Related article: Crying wolf: For OPEC talk is cheap
Earlier this week BMI published a note estimating a 45% probability of a “wait and see” stance and no deal on output cuts. This seems much too high.
First, OPEC would not have factored in Trumps’ victory in the US elections.
The short term impact thus far has been a strengthening in the US dollar which has also contributed to the fall in the price of oil, which if as many expect the dollar bull run has much further to run then the headwind to oil prices will intensify.
Trump’s victory puts Iran in a much weaker position now. If Trump tears up the agreement to remove sanctions from Iran then the ability of Iran to increase exports is weakened considerably.
Trump has also indicated that he wants the US to wean itself off Middle East oil completely. Although this is always likely to be completely impractical (many refineries are built to use just the type of crude oil that Saudi’s and others supplies) it presents a much more confrontational edge to the relationship.
Secondly, all OPEC members badly need higher oil prices to help reduce funding costs – from food shortages in Venezuela to an increase in the cost of insuring debt in Saudi Arabia.
According to PIRA failure to implement a deal could see prices fall as low as $35 per barrel, while $60 per barrel could be seen if the group is successful. BP, speaking before the latest verbal intervention were less pessimistic saying “You see that in the price,” he said. If the talks fail, prices “will stay around the level we’re at [~$43 per barrel].”
Finally, and most importantly they have to cut. Since first noting the groups attempts to try to stabilise prices OPEC has embarked on doing exactly the opposite, increasing output as much as possible so that when they do have to cut they are the ones holding all the cards. OPEC can’t keep playing this game of Top Trumps forever. If they don’t stop, their credibility will be shot and the game will just not be worth playing anymore.