The drama in oil

Further record prints for the US markets overnight, as stimulus from three of the four largest central banks, coupled with solid state specific economy data, allowed investors to keep the long auto-pilot on.

Source: Bloomberg

With Thanksgiving on Thursday there’s no reason to see the current trend in the US markets stopping this week. However, Thursday’s OPEC announcement will be an interesting situation for oil.

The collapse in the oil price has caught most off-guard; the US shale-gas revolution is diluting the economics of the oil price and sees the fundamentals of the OPEC bloc deteriorating. It’s in OPEC’s interests to start to balance the economics of the oil price, having seen the supply side of the equation rapidly expanding - driving the price down.

Most in the market expect OPEC to announce a modest reduction to production on Thursday. However, considering the erratic communication coming out of the bloc and the reaction of the Brent price on the back of these communiques, a coordinated response looks unlikely.

Realistically, Saudi Arabia is unlikely to cut production and has been resisting the call for the past few weeks. However, Libya, Iraq and Iran are likely to break ranks here and continue on their current plans to bring production in line with global consumption. As early as this morning, Iraq announced that oil prices are not acceptable and that something needs to be done. Iran has also announced it is looking at lowering production to an estimated of one million barrels a day - a 7% to 10% reduction on current levels.

The likely trade reactions to Thursday’s announcement will be modest, as it will take several months to allow excess supply to exit the system. However, the option market in Brent is becoming skewed to the upside on the possibility of larger cuts (Saudi Arabia coming to the party). As I said, it is in the interest of the bloc for prices to stabilise and rise over the medium term and future derivative markets are starting to reflect this.

Iran might also skew the market’s reaction. It looks very unlikely the nation will reach a new deal around its nuclear programme. News coming out of the talks in Vienna suggests the current interim deal will expire. That will see the current sanctions on Tehran remaining, meaning Iran will see its oil exports slapped with heavy tariffs. If a deal is reached, however, and some of these sanctions are lifted, then again there is likely to be upside risk in the price of oil.

The price slide in oil has seen energy plays shedding double digit percentages despite the fundaments and the quality of assets. If we do see a surprise on Thursday coming out of OPEC, these plays across the globe are likely to also experience upside surprise.

Ahead of the Australian Open

The positive market hit from Friday’s stimulus measures coming out of China looks to be very short lived; despite near enough to 4% rallies for BHP and RIO, the London listings fell through the floor overnight and are likely to drag on the market today. We are calling the ASX 200 down 23 points on the open to 5338, as the materials plays give back most of yesterday’s gains. Most market watchers and investors alike are more likely to be glued to the market at 12pm, as the largest privatisation of a state-owned enterprise since Telstra T3 in Medibank Private lists. Considering the slender allocations to institutional investors, trade volumes are likely to be strong with an upside bias. IG’s grey market in Medibank closed at $2.28. Trade in the grey market will end at the close of business today, signs of bidding will see it higher still.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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