Well you wouldn't expect things to go smoothly, would you?...

Wednesday 26th October 2016

  

Well you wouldn't expect things to go smoothly, would you? It's Oil, OPEC and oversupply ......

ref:-  "Oil Falls as US Supply Seen Rising While Russia Dismisses Cuts", Bloomberg Markets

Regulars would know that we like to dip into the oil market fairly regularly, and for good reason. The price of oil, directly or indirectly, affects just about everything we look at from inflation and its knock-on effects on interest rates, bond markets and currencies, through emerging markets and commodities, all the way to how it shapes some of the most delicate and crucial geopolitical issues of the day. Just recently we examined the successful and high-profile debuts of Middle Eastern nations in the international debt markets  --  an important part of the modernisation process in the move to wean economies off near-total reliance on oil for sure, but most crucially a reflection of oil trading at $50 (or lower).

Like most observers, we were surprised by the announcement at the end of last month that after talks on the fringes of a wider get-together of oil producers in Algiers, OPEC members had agreed to curb daily production to 32.5 - 33 million barrels.

Details are to announced at the regular OPEC meeting at the end of November (all being well). Moreover, the biggest non-OPEC producer  --  Russia  --  not only helped to broker the agreement but offered, through President Putin no less,  to restrain their own production in a move to support higher prices. If we remember correctly, we offered the opinion that some caution was advisable for those assuming that all the good intentions would automatically be matched by deeds, and we even rather cynically suggested that Russia had only just increased production to record and possibly unsustainable levels of over 11m bpd precisely so that might look responsible when they trimmed output. It turns out that we might not have been cynical enough .....

Almost immediately after the Algiers announcement Igor Sechin, boss of the giant Russian oil company Rosneft (state-owned, remember), seemed to suggest that Russian output would continue at full tilt. He then backtracked from his comments and for many it was easy to assume that someone from the Kremlin might have had a word in his ear. Now however Russia's envoy to OPEC is quoted by Interfax as saying that production cuts are NOT on the agenda, and that a production freeze is the preferred route. It maybe just us, but to offer to freeze output at what must be close to full capacity anyway doesn't seem particularly magnanimous.

And within OPEC itself, divisions are appearing as to just how any cut in production is going to be apportioned between members (yes yes, we know .... shock horror etc etc). The most surprising element of the Algiers announcement was that Saudi Arabia was prepared to reduce output while agreeing that arch-rival Iran might maintain theirs as they recover from economic sanctions. We assume that other major OPEC producers are expected to shoulder their share of the cuts, but Iraq has just said that they should be exempt from any cuts on account of their conflict with Islamic militants. What they did not say but is universally understood and seems a perfectly legitimate argument, is that they are fighting a costly war within their own borders against a common enemy  --  in stark contrast to Saudi Arabia and Iran, who are fighting costly PROXY wars by supporting opposing forces in Yemen and Syria.

An OPEC committee is meeting this week to attempt to reconcile all parties. We're going to see a lot of this before the Nov 30th meeting in Vienna. Without doubt, OPEC need to get this agreement signed and adhered to but without being deliberately repetitive, there is much to resolve. All the usual cautionary warnings apply.

On top of all this, US crude oil inventories rose unexpectedly by 4.75 million barrels last week, according to the American Petroleum Institute. Now these readings of inventory levels are notoriously volatile (watch out for Energy Information Administration data due today), but they do little for the argument being made by oil bulls that the glut of oil reserves is diminishing.

And the effect on prices? Lower for the third day in a row as recognition of the hurdles still to be overcome tempers the post-Algiers optimism. Brent crude for December delivery is trading at $49.98, down about 1.6% on the day. The recent high was about $54, which means that if commentators were talking about moving into a new, higher price range of $50 - $60 two weeks ago, now you're more likely to hear something a bit lower, with Bloomberg quoting CMC Markets as saying that there is potential for oil to return to the bottom of the range in the low $40s. All things are possible of course, but cash-strapped oil producers will be praying that OPEC can really put something together this time that'll make such pessimistic musings redundant.