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OPEC surprises the market — can oil hit $50?

In a recent report piece titled ‘Oil in focus as OPEC members meet, and Trump looms over dollar’, I looked at three key risks for the oil market this week: the first US presidential debate, the weekly oil inventory report and the OPEC meeting.

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Source: Bloomberg

The effect of these events are high oil prices and a market that has been fairly surprised by the news flow. The presidential debate was modestly positive for the oil market. The Department of Energy (DoE) inventory showed a drawdown of 1.88 million barrels of crude oil last week, while gasoline inventories increased by 2.02 million. However, the key driver has clearly been the OPEC meeting.

Most in the market (including yours truly) were sceptical of anything tangible being announced from OPEC, although I had suspected the talks would be constructive and detail a clear path for more hard-hitting rhetoric in the November meeting.

What has transpired, though, is certainly above market expectations and price has responded in kind, with US crude hitting a high of $47.63 with the bulls pushing price out of the recent consolidation triangle. We can see momentum accelerating to the upside, with the five-day moving average (MA) pulling away from the 20-day MA. We should be watching for a move into $48.12 (the 8 September high) and potentially even the 19 August high of $49.30 in the short-term.

We know that OPEC have agreed in principle to a modest cut in production of around 750,000 barrels a day among the various member nations. However, the actual allocation of cuts by the various nations is yet to be announced and the finer details are likely to be reported in the November OPEC meeting.

This was clearly above and beyond expectations and it was effectively the first time the cartel have shown signs of solidarity since 2008 – from that perspective this was a new development. Still, it must be remembered that while OPEC is showing signs of solidarity, the group make up just less than 40% of global oil output. Russia are producing over 11 million barrels a day and we have seen US shale gas producers increase their output, with the Baker-Hughes drill rig count increasing 32% since May to currently sit at 418 rigs.

US shale producers mostly breakeven around $50 a barrel, so a move above $50 could see additional rigs come online and act as a headwind to price given the additional supply.

There are concerns about the execution of OPEC’s new production targets and many actually feel that the headlines are more bullish than the reality of the situation. Even when the new agreement is finalised, the actual reductions won’t materialise until 2017 and the prospect of various nations exceeding targets is real. Furthermore, OPEC need to convince the Russians to halt production, although early signs are that they have indeed shown some interest in freezing production.

Traders have to be nimble and this is a traders’ market. Using short-term timeframes rather than daily charts seems logical in this instance. Still, with the execution risk to the OPEC plan and US shale companies ready to ramp up production on moves above $50, the upside seems limited, even though the technicals are clearly favouring long positions at present.

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