Thanksgiving In Vienna: OPEC Meeting
On Thursday, November 27, as the US is celebrating the Thanksgiving holiday, members of the Organization of the Petroleum Exporting Countries (OPEC) will sit down in Vienna, Austria to discuss the current state of the world crude oil market. The mission of OPEC, as stated on their web site, 'is to coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital to those investing in the petroleum industry.' OPEC is a cartel. A cartel is an agreement between competing entities to control prices or exclude entry of a new competitor in a market. OPEC is a public cartel meaning that the sovereignty of nations shield OPEC from legal actions as it, in theory, operates for the good of the populous as a whole. The current OPEC members include Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela. Oil is perhaps the most political commodity produced. The master commodity trader, Marc Rich, once said that oil is the blood that flows through the veins of the world. The political nature of crude oil stems from its production sources and the ubiquitous nature of oil consumption.
OPEC and oil producing nations have enjoyed a decade of high prices; let us not forget that prior to April 2004, the price of crude oil never exceeded $41.15 per barrel.
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Recently, due to increased Canadian and US production coupled with a global economic slowdown, increasing inventories have resulted in a lower price for crude oil. Since June, the price of NYMEX crude has decreased from $107.73 to a low of $73.25, closing Friday, November 21 at $76.51 - a decrease of 29%. Brent North Sea crude and other grades as well as oil product prices have decreased a commensurate amount during the past five months. Therefore, the OPEC meeting this week comes at a perilous time for many oil-producing countries, and will be the most important and closely watched meeting of the cartel in many years.
Vested interest all over the place
The amount of oil produced around the world, by OPEC and non-OPEC members, has increased due to high prices for the commodity. The higher-cost production has taken power and influence away from the cartel. Production from non-OPEC members like Russia and the US has eaten into the cartel's market share. In a 2014 report, OPEC claimed that 81%, over 1.2 trillion barrels, of the world's proven oil reserves are located in OPEC member countries with the bulk in the Middle East - 66% of the OPEC total. OPEC supplies between 30%-40% of the world's oil.
At recent high prices the US, traditionally an importer of crude, is oil independent. A lower oil price would shutter high-cost production, thus giving OPEC more power and influence. A higher oil price results in more cash flow for the cartel members. Many OPEC members produce at very low cost. To paraphrase Hamlet, 'to cut or not to cut (production), that is the question' that the twelve oil ministers in Vienna will have to answer this week.
If OPEC opts to cut production, it will squeeze the coffers of poorer members like Algeria, Nigeria and Venezuela. These members may be unwilling to reduce their own production, and the big rich members like Saudi Arabia and Kuwait may refuse to cut on their own. Iran has already indicated that they favor a production cut. Poorer OPEC members may look to the richer members to take the brunt of any cuts.
To confuse matters even more, Saudi Arabia (OPEC's most influential member) and Russia (a non-OPEC member) are the world's biggest oil exporters. Russia will send representatives to Vienna this week in order to coordinate on issues of mutual interest. Russia and Saudi Arabia will confer on issues while the West continues to put pressure on Mr. Putin over his actions in Ukraine. Furthermore, negotiations for a nuclear non-proliferation treaty with Iran, another influential OPEC member continue, coincidentally in Vienna. The deadline for those negotiations is Monday, November 24, but an extension is certainly possible. An agreement with Iran could include a lifting of sanctions making more Iranian crude available to the market.
Every OPEC country and non-OPEC oil producing or consuming country has a stake in the outcome of Thursday's meeting in Vienna. The Saudis are very much caught in the middle. As the nation with the richest oil reserves in the world, it would be in their interest to let oil prices fall so that higher-cost production becomes uneconomic. However, in the interest of stability and fairness, it is not likely that the Saudis will take this path. In fact, the biggest fear the Saudis have these days has nothing to do with oil. The kingdom is most concerned with the increasing influence and threat of ISIS in Syria and Iraq and the terrorists' design on Saudi Arabia, the home of Mecca and other holy sites. The Saudis are in a coalition with the US fighting ISIS, so they must be sensitive to US concerns and desires to remain energy independent. When it comes to Thursday's OPEC meeting, the issues are so complex and convoluted, and they transcend the price of crude oil alone.
Volatility has decreased - open interest has decreased
Crude oil fell like a stone since June. On November 14, the price of NYMEX active month crude oil futures fell below long-term support at $74.95, the October 2011 lows. Since then prices have recovered, slightly. As the OPEC meeting nears, crude oil prices have stabilized above $75 per barrel with the market holding its breath awaiting results of the meeting and production decisions. In the meantime, speculative positions in NYMEX crude oil futures have decreased. Since November 13, open interest, the total number of long and short positions, has decreased 9% in six trading sessions. Technical action is telling us that all eyes are on OPEC.
Oil products, gasoline and heating oil, have moved lower with the price of crude oil. Crack spreads or the processing spreads for refining raw crude oil into oil products indicate that product demand has mirrored the action in crude oil. While gasoline cracks have fallen from $25.30 per barrel on June 16 to $9.33 last week, seasonal weakness at this time of the year explains the decrease. Heating oil cracks that were at $22.71 per barrel on June 16 closed last week at $22.83, virtually unchanged. Heating oil has moved in lock step with crude despite a frigid early beginning to winter with snow cover over half the US and cold sweeping across two-thirds of the country in early November. The lack of strength in heating oil highlights the current oversupply in the crude and product markets.
In June 2014, NYMEX crude oil was in a steep backwardation, deferred prices were trading at lower prices than nearby prices. As an example, January 2015 NYMEX crude versus January 2018 NYMEX crude traded at a backwardation of $14.68 - the 2018 crude oil was $14.68 cheaper than the nearby. At the close of business this past Friday, that spread moved to a $2.85 contango - meaning that now January 2018 crude oil is a premium to nearby crude. The move in the spread is significant - $17.53 per barrel. This means that nearby January NYMEX crude has dropped just over $24 since June 16, while January 2018 crude has only dropped $6.75. A market that moves from backwardation to contango indicates that there are no current supply concerns.
While backwardation often highlights supply concerns, many believe that crude oil had a risk premium due to political issues in the Middle East and Russia. A lower oil price suggests that those political risks have decreased. However, given political turmoil and war in Syria, Iraq and Ukraine in some senses, political risk has ramped up since June. Therefore, it is clear that lower crude prices and a forward curve that has moved from backwardation to contango is the result of oversupply and weak overall global demand. Economic weakness and global supply will be the issues that OPEC turns its focus to on Thursday.
Gravitation to $80 per barrel...
I wrote two articles for Seeking Alpha over the past few months about deteriorating oil prices. On October 14, when active month NYMEX crude oil was just under $86 per barrel, Crude Oil: So very bearish, but is there a price floor at $80 opined that the crude oil price will be managed by a backroom agreement between the US and Saudis, partners in the fight against ISIS. On November 11 Managed Oil Prices- Is $80 the new pivot point, I expressed the opinion that $80 could be the perfect price for crude. $80 keeps the US oil independent and the Saudis can certainly live with that price. Additionally, $80 is a price that keeps pressure on Russia and the Iranians, as well as helps the US and Chinese economies grow.
Since I wrote those pieces, the price of crude oil traded down to the low 70s, where it found support. This week's OPEC meeting will provide the best evidence yet of whether an agreement between the US and Saudis to manage crude oil prices is actually in place. Analyst forecasts split down the middle on whether OPEC will cut production, which indicates that at this point it is a coin toss. I believe that OPEC, via Saudi manipulation and cooptation, will walk away from Thursday's meeting with a consensus goal of stabilizing crude oil prices at the sweet spot - $80 per barrel.
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