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What does the OPEC meeting mean for oil prices?

What does the OPEC meeting mean for oil prices?

1. OPEC vs non-OPEC supply-effect Since the last historic OPEC meeting in which the once dominant oil cartel chose not to cut production, Saudi Arabia, the organisation’s de facto leader, has actually increased production. The decision not to cut production, coupled with the action of increasing production afterwards, indicates a policy focused on market share instead of price. Such a long-term policy that relies on the demise of competition to eventually lift prices is unlikely to change in the space of six months. The countries that dominate OPEC decision-making understood that by cutting their own production, higher cost producers like US shale would have taken advantage of the higher price to increase their own production. Essentially, Saudi Arabia understood that it’s not the swing producer it once was. If it were to cut production, other non-OPEC members like Russia, China and Brazil needed to cut as well to make it effective. The decision at the last meeting has had mixed results. The price of oil nosedived from around $70 per barrel to almost $40, taking a huge bite out of the national revenues of oil-producing counties. The lower oil price resulted in a 50% drop in the number of US oil rigs but only in the last few weeks has production actually started to decline as indicated by US inventories. OPEC has gone to war with higher cost non-OPEC countries and is unlikely to back down after winning the first battle. OPEC will more than likely maintain its quota at its June meeting. Libya and Iraq are producing more oil after production slowed during conflict. Iran looks like it will soon be exporting more, depending on whether its nuclear pact with the USA will lead to the removal of sanctions. Overall, the trend for Middle-Eastern production appears to be higher, adding to the global supply glut and putting downward pressure on oil prices. Brent crude has jumped over 50% from the lows in January, from $45 per barrel to almost $70. This was in part because of the anticipation of slowing US production, but other factors outside of OPEC’s control, most notably a two-month decline in the value of the US dollar, have contributed. 2. The US dollar-effect Oil, like most commodities, is denominated in US dollars. The dollar was sought as a safe-haven during the onset of the financial crisis in 2008 but the expectation and implementation of the Federal Reserve’s quantitative easing program artificially devalued it by creating excess supply. The taper and ending of QE has seen demand for dollars surge again. The chart below shows an overlay of crude oil and the euro. Crude oil’s specific supply/demand dynamics as well as its inherent greater volatility means it moved more than the euro. The inflection points of the fall and rise happen around the same time, demonstrating the importance of the US dollar in the movement of both assets. (Chart source: Bloomberg) If the Federal Reserve starts to raise interest rates investors will, theoretically, move assets into US dollars to earn higher returns on what is perceived to be a safer market. If the price of oil is held down by US dollar strength, OPEC would do better to intervene because falling US oil supplies by itself may not have the needed effect on prices. 3. The commodity-effect The economic slowdown in China, the world’s biggest consumer of commodities, has impacted physical demand for a number of commodities including iron ore, copper and even gold and silver. Like in the oil industry, many miners positioned production levels for higher levels of demand, resulting in over-supply of the commodities. Any decision by OPEC to cut supply can only be effective if there is not enough demand for oil in the first place. The chart below shows the decline in oil has happened at the same time as a decline in other commodities, but its own specific supply-glut has meant the decline has been steeper. Twelve-month chart of Brent crude oil versus the CRB commodity index (Chart source: Bloomberg) Even if US oil production does come down, until there are widespread defaults amongst US firms, it is likely to be a gradual reduction. US dollar strength and a global growth slowdown (especially in China) have the potential to weigh on oil prices. While OPEC is likely to stay the course in June, if oil prices are still low six months later at the next meeting, infighting amongst OPEC members under pressure to raise state revenues could make the decision less clear. CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

Read all of our Q3 articles:

Neutral outlook for sterling as UK growth evens off Cooling China brings ANZ back to the pack Q3 market outlook: sector performance and earnings season preview European economy faces significant headwinds Bonds: all traders should be watching bond charts Overvaluation of stock markets and wishful thinking Chinese equities: Will it all end in tears? The Japanese stock market could continue to rise in the coming months Q3 market outlook: a swing trading summer looming for US markets?

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