What To Expect In The Oil Market
The latest rumor around the global water cooler that Russia and OPEC-leader Saudi Arabia have agreed to freeze oil production at January or February levels has been dispelled… for now.
The OPEC leaders meeting in Doha failed to reach an agreement to cap production, with Iran bowing out of the meeting altogether, and refusing to pull back on its oil production. As a result, oil prices took a big tumble. Brent crude fell a harsh 7% on the news. West Texas Intermediate (WTI) fell almost as much at 6.6%.
#-ad_banner-#But does a “no deal” result from the OPEC Doha meeting mean production caps are off the table? Or that OPEC wouldn’t seek an alliance outside its cartel?
In response to the meeting, Qatar’s energy minister Mohammed bin Saleh al-Sada said, “We of course respect [Iran’s] position… The freeze could be more effective definitely if major producers, be it from OPEC members like Iran and others, as well as non-OPEC members, are included in the freeze.”
Al-Sada said that OPEC members need more time. Which says to me that this won’t be the last we hear of production caps.
Indeed, this wasn’t the first time we’d heard about potential cooperation between OPEC and Russia, either.
The rumor of a possible oil production freeze lifted oil markets as much as 4.7% and kept prices for WTI above $41 mid-week last week. That means oil prices have been on a wild ride. Take a look at WTI futures:
WTI Futures (4/14/16-4/19/16)
Up and down and up again.
But now that we have the answer to the rumor, the question is… What now? We’ve already seen oil prices crawl back from their big drop over the weekend.
Well, we have to stick with what we know.
There isn’t a corner of the world that isn’t touched by OPEC and Russian oil. An alliance would’ve been extremely powerful, and I would bet that after a little time passes, this rumor will start circling around again. Perhaps then, Iran might be more willing to talk about production caps.
But I’m getting ahead of myself.
We’ve seen oil prices push sharply higher right up to the Doha meeting. In total, prices climbed 19.5% since Tuesday, April 5 through April 15.
On April 8 we saw firm economic data that stoked optimistic oil demand forecasts. That could help robust economies start to eat into the oil supply glut regardless of whether or not Russia and OPEC had teamed up.
And as that oil glut shrinks, oil prices will climb. That could put U.S. production back on the table if oil prices get in the $50-55 range. In effect, that price level will become a ceiling for oil. And even a New Oil Alliance wouldn’t be able to break it.
The key to understanding this dynamic is see it as a slow-burn kind of price movement. Oil gluts don’t disappear overnight. And neither does excess production. That’s why the U.S. continued to see strong oil production through the end of 2015. And each time we see oil prices tick higher, U.S. producers get ready to ramp up production.
Saudi Arabia and Russia, while they can’t seem to get together to agree to halt production, would sure like to see some relief from low oil prices.
Both economies are suffering, and that’s why Saudi Arabia, and some other OPEC nations are still hopeful for an alliance down the road.
What To Watch In The Oil Market
But in the meantime, Russia has stated publicly that it would not join OPEC in any production scheme. Saudi Arabia has also said that it would not freeze production levels without the cooperation of its rival, Iran.
The fact that Iran didn’t even show up in Doha proves how serious the country is about making up for lost time due to sanction.
We also know that if some freeze does come to be, U.S. producers will start producing again once oil prices climb high enough.
All that put together tells investors that despite the recent rise in oil prices, there’s a lot more uncertainty in oil’s future. Investors should focus on two things: how much oversupply we have, and how quickly demand is growing. Those are the two factors that will be driving oil prices for the next year or two.
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