OPEC Freeze?

Today OPEC ministers concluded a two-day meeting in Algeria. The weeks leading up to the meeting were filled with rumors that OPEC was close to agreeing a production freeze. As usual, during this period, various OPEC members leaked information to financial news outlets causing heightened price volatility. The consensus amongst analysts was that the meting would ultimately conclude without a production freeze agreement.

Late this afternoon, OPEC announced that the group had reached a consensus that output cuts were necessary to rebalance the market. Caught off guard by the announcement, traders reacted by immediately pushing the price of crude up by 5 percent.

As the smoke started to clear this evening and the details, or lack thereof, began to surface it seems the “agreement” is more aspirational that functional. While the agreement marks a possible shift in strategy on the part of Saudi Arabia, it lacks important details. Specifically, today’s announcement did not include any information about the overall extent of cuts to be made by the group or which members would bear the burden thereof. In fact, there were statements made by individual ministers that certain members would be exempted from the cuts and be allowed to continue to increase production - Iran, Nigeria and Libya. The issue of which members are to curtail production and by how much was put off to the next OPEC meeting in November, where non-OPEC members (specifically Russia) would be invited to join the initiative. As a consequence, today’s announcement will have little, to no, impact on current market fundamentals. The market is, and for the next few months, will continue to be materially oversupplied with crude.

Although today’s announcement was taken by the market as bullish, we remain sceptical. In our view it is too early to state conclusively that Saudi Arabia has abandoned its prior policy of market share over price. Even if OPEC were to attempt to transition today’s aspirational agreement into a functioning one in November, it is difficult to ascertain which OPEC members would voluntarily agree to curtail production particularly when such cuts most likely will be partially, or wholly, offset by increases from other producers - Nigeria, Libya, Iran and Russia.

Today’s announcement was a realization on the part of OPEC that the market is continuing to face significant challenges (excess supply, record inventories, and slack demand) and rebalancing without a production cut if further out into the future that most originally expected. There is however a wide chasm between recognizing a problem and implementing the steps necessary to cure the problem. OPEC members continue to have disparate and competing national interests and they are keenly aware that any action taken to rebalance the market can be largely offset by non-OPEC producers (US and Russia). There is still a long distance to travel between today’s announcement and an actual production freeze - in the meantime underlying fundamental remain bearish. The one thing that OPEC did prove today, beyond a shadow of a doubt, is that it has learned from the world’s central banks on how to exploit headline news to accomplish their objective without actually undertaking any meaningful action.

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