OPEC Preview: Deal or no deal

The classic problem of a Prisoners’ Dilemma is perfectly exhibited in the upcoming November 30 Organization of the Petroleum Exporting Countries (OPEC) Ordinary meeting. 

Oil
Source: Bloomberg

Around the table we have Saudi Arabia championing and coordinating the agreement and wild cards players, Russia (non-OPEC), Iraq and Iran wavering in their communications. A production cut would mean higher prices for everyone, but who should shoulder the reduction in output quantity?

The build up to the anticipation for the November 30th meeting had started with the Algier conference on 28 September where OPEC members agreed to the outline of a deal for a production cut, with details to be worked out in the November 30 meeting. In the interim, we have seen crude oil prices and related markets jostled by the comments from key players. Optimism had prevailed thus far with positive comments reaching the wires, although the lack of commitment from Iran and Iraq in the latest technical meeting increases the event risk for next week.

We are seeing prices struggling between the two ends of a production freeze which could send Olja - US Crude prices retesting the $52.00/bbl resistance or down towards $40.00/bbl should the talks fall through.

 

Base case scenario: A half-hearted freeze

This is by far the most likely scenario according to the market. As things stand, the OPEC committee is highly likely to stick to their words, despite the noise surrounding discussions thus far. On the line would be a huge dent to oil prices and also the reputation of OPEC as a ‘price-maker’.

A target of 32.5-33.0mmb/day had been cited in the Algiers Extraordinary Meeting with a period of at least six months, a tad lower than the 34.0mmb/day seen a week prior to the meeting. The latest verdict from Iraq, OPEC’s second-largest producer, indicates that the country would shoulder part of the burden alongside Saudi Arabia, bringing us a step closer to an agreement.

However, even if we should get an agreement, there remains risks for the market with the actual implementation a difficult task. Furthermore, we could be revisiting the current situation in six months with the delicate balance where participants will be incentivized to defect. Nigeria and Libya, together forming slightly more than 6% of OPEC output, will also likely be granted exemptions that could undermine an actual drop in supply with the agreement.

 

Alternative scenario: Let’s talk again

Should the members agree on the belief that the cuts will be shouldered by others, we are in for trouble and that could stall progress once again. Supporting this possibility had been Russia’s stand, as a crucial non-OPEC producer, which reiterates their preference for an output freeze than cut. OPEC members had been insistent for Russia to partake the cut in order to establish a collective agreement.

Another wild card will also be Iran, number 3 on the OPEC output chart. Recalling that a deal had failed to be established earlier in the year on the account of the reluctance from this oil exporter. Reassurances had been heard from Iran’s oil minister, though the adjectives remained along the “probable” lines.

This alternative scenario, though less likely, still has the possibility to sink US crude down to the $40 range.

 

Trading the OPEC meeting

Oil - US Crude

Technical analysis currently provides some support for prices. For participants bullish on the meeting, upsides are exposed to the $52.00/bbl resistance while vice versa, the lows could extend to $40.00/bbl. 

US 500

At approximately 7.3% weightage, energy plays a substantial role in influencing the direction of the S&P 500 index. A more moderate movement could be seen here as compared to the US crude market. Nevertheless, the strong upward momentum will see the downside supported by the resistance-turned-support at 2,200 levels should the OPEC agreement fall through. 

USD/CAD

USD/CAD has been reflecting the strong dollar lately, though the oil-influenced CAD could reap some gains should crude oil prices see strong gains. This downward pull on USD/CAD will be further aggravated with the negative correlation between the dollar and commodity prices. Technical analysis sees strong resistance at the 50% Fibonacci retracement level coinciding with the recent high of about $1.36 which could see a reverse to the upward trend should oil prices experience a higher-than-expected jump. 

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