OPEC look ahead: to freeze or not to freeze

With speculation rife that we will see oil producers reach an agreement in an attempt to prop up crude prices, what are the chances of a production freeze and would it even make a difference?

Oil rig
Source: Bloomberg

September’s OPEC meeting provides yet another hotly anticipated event which has the propensity to shape the value of crude for months to come, as members and non-members alike seek to build on the gains seen in H1 2016. Not only have traders got to deal with the uncertainty caused by conflicting comments from each nation, but we still do not know exactly who will be in attendance.

This whole affair revolves around the ability to freeze production as a means to raise crude prices by means of restricting supply. However, the ability to really make a difference is arguably undermined by the fact that we have seen members increase production in the months leading to this meeting. The chart below highlights that OPEC output is a significant determinant of crude prices, with rising production typically driving prices lower. 

With that in mind, the ability to restrict production should in turn impact price. This would make sense apart from the fact that the meeting is aimed at halting any further increase in production rather than any substantial cut. However, as we can see below, we have seen nations ramp up production in anticipation of a freeze, thus ensuring that any freeze would simply maintain an incredibly high rate of production rather than reduce it.

Would such a freeze even drive prices higher? Not for long. By maintaining production, amid a wider environment where the US can continue to ramp up production, the best such an agreement can do is stabilize prices.

The big question is whether any such agreement will even be reached at all, with the answer looking very different depending on who you listen to. We know that most OPEC members are hugely reliant upon oil revenues and have sought to raise prices as a means to grow margins and profitability once more. We have also seen the Iraqi PM come out in support of such a freeze in comments this week.

However, the ability to halt production resides in Saudi Arabian and Iranian hands. Saudi Arabia have shown themselves to not only be a roadblock to any action, but they were ultimately the brainchild of the current supply glut, which is driving prices lower.

What started as a campaign to drive out the growing US shale producers is now turning into a two-way battle, with the Saudis also refusing to budge if their arch nemesis Iran does not do the same. Recent comments from the Iranian oil minister highlight that it may not be as simple as first though.

The Iranian stance is that "Iran will cooperate with OPEC to help the oil market recover, but expects others to respect its rights to regain its lost share of the market," in essence, Iran is happy for others to freeze production, so long as they continue to increase production (and in turn market share).

There is little chance that the Saudis will agree to this, especially when the US is also raising production levels. Granted, Iran is gradually moving towards their pre-sanctions production level, yet who is to say that they will wish to simply match previous output and not match that of other similar nations?

What we ultimately are faced with is a decision by Saudi Arabia to freeze production, thus gradually losing market share to their two main opponents in the US and Iran. It does not seem likely. The Saudis have already raised production sharply in the lead up to this meeting, yet while this raises the chance of a production freeze (they have already gained market share in recent months), it also minimizes the desired impact upon crude prices.

In summary, this meeting looks unlikely to yield a deal which will satisfy the markets that the recent oil glut is anywhere near ending. With Iran and the US expected to raise output regardless of the meeting’s conclusion, the Saudi’s are unlikely to go along with any such deal. Yet for those crude bulls hoping for a deal, there is a good chance that any such deal would be insufficient to raise crude prices for any prolonged period.

The Brent chart below highlights this week’s break through a crucial support level at $48.82 has given way to a sharp deterioration in price. This seems likely to continue, with the next key support levels coming into play around $47.26 followed by a descending trendline (currently $46.64).

However, for now, it seems likely that we are going to see this market trend lower, with the continued creation of intraday lower highs and lower lows expected to provide numerous short-term selling opportunities.

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