FxWirePro: Decide precisely whether truth or hype ahead of OPEC meeting

Crude oil markets are growing nervous, days before OPEC is due to meet in Vienna on 30 November. Front-month prices on ICE Brent are currently retracing around $62.37, down $2.23 from the November highs and putting a pause to a four-month rally.

We expect a six- or nine-month extension of the OPEC deal to be agreed to on November 30, but the extension length is less important than the quota level. Whether or not the countries extend and the duration of the deal are not the relevant questions in our view. We believe the level of the cut is what really matters, and we assign a low likelihood to this detail being announced on November 30.

The OPEC/Non-OPEC Declaration of Cooperation (DC) was always meant to be flexible. The Joint Technical Committee and Joint Ministerial Monitoring Committee can suggest changes at any time. Even if the deal ‘ends,’ we would not expect an onslaught of new production from DC participants.

On November 30, member countries are unlikely to provide clarity on production levels in 2018, leaving the market to presume that the cuts will remain intact. That would be a misguided assumption in our view, and we do not expect these levels to remain static during 2018.

However, the market-management mode should remain the theme for the foreseeable future. The alternative, lower prices, should keep all countries in support. Significant swing potential revolves around the flexible four: Saudi Arabia, Russia, UAE, and Kuwait. Other participants are unlikely to veer from their current output trajectories, in our view.

Understand what motivates the flexible four. The sustainability of the deal depends on how much longer they are willing to sacrifice market share in the pursuit of revenue and market stability.

Oil diplomacy should prevail over renewed geopolitical tensions, reducing the likelihood of a repeat of the failed Doha agreement in April 2016. Large financing needs in the Kingdom of Saudi Arabia, along with protracted fiscal consolidation and recent political reshuffling, will increase the near-term focus on oil price stability. Russia will also remain supportive since economic vulnerabilities have not gone away and a presidential election is scheduled for March 2018.

Assuming OPEC and non-OPEC participants (‘NOPEC’) sustain current output levels, the global s/d balance would slip from a slight surplus to a slight deficit. All else equal, reducing the output from these countries by a further 550 kb/d would lower inventories by 153mb during Q2 to Q4 2018. But in the $60-70/b range, US tight oil, Chinese import levels, and global oil demand growth will not stand still and would likely cause a hangover for the oil market.

This week, we expect volatile prices as market participants shed length. Prices might fall in the immediate aftermath of the deal as speculative length ‘sells the news.’ Still, fundamentals should keep Brent at an average of $60/b this quarter.

We, therefore, recommend buying Dec 18 NYMEX WTI vs Brent at current levels ($5.25). The current WTI-Brent spread curve is in backwardation from May 2018 onwards, which should further benefit the trade. Should the spread not narrow by April however, we recommend closing the trade on a steeply contangoed spread curve.

Brent futures, the benchmark for oil prices outside the U.S., shed 39 cents from the day highs to $63.48 a barrel by 12:20 GMT.