Anyone planning to trade
the outcome of this week’s OPEC meeting might consider the lessons of the
group’s last production cut. Then take a deep breath.
In December 2008,as
oil demand and prices slumped during the global financial crisis, the
Organization of Petroleum Exporting Countries, announced a record output
reduction. What was supposed to stabilize the market initially sowed more
confusion as the group’s statement bundled together previously announced supply
curbs and omitted a breakdown of how much each member would cut -- details of
which leaked out days later.
While the deal did
eventually halt the slide in prices, the Chicago Board Options Exchange Crude
Oil Volatility Index,a common measure of market turbulence,stayed
near a record over the following two months amid doubts that OPEC members would
comply with their new targets.
"OPEC meetings can be
messy, and the outcomes can also be messy,” said Mike Wittner, global head of
oil research at Societe Generale SA. "If there is a deal, the question for the
markets will be whether it is a strong deal or a weak deal, and this will be
determined by the level of detail announced by OPEC.”
In the two-month run-up to
this week’s meeting in Vienna, oil has swung between $44 and $53 a barrel amid
investor skepticism that OPEC can deliver on its Sept. 28 pledge in Algiers to
cut output to the 32.5 million to 33 million barrels a day.A deal founded
on a group target would see crude trade around $45 a barrel, preceded by some
price volatility, according to Thomas Pugh, acommodities economist at
Capital Economics. He assigns a 60 percent probability to that outcome.
Technical Committee
A technical committee of
OPEC delegates last week sent a proposal to the organization’s oil ministers,
recommending that most members cut output by 4 to 5 percent from the October
level estimated by independent sources. Yet, it was unclear whether Iraq and
Iran -- OPEC’s second and third-largest producers -- accepted such reductions
and what level they would be asked to cut from, forcing the committee to tackle
the issue again on Monday.
With Iran and Iraq proving
difficult to persuade, OPEC "may have to opt for an opaque statement about
burden sharing in order to get an agreement inked,” Helima Croft, head of
commodity strategy at RBC Capital Markets, said by e-mail.
Iraq has argued it should
be exempted from cuts as it’s fighting Islamic State militants. Its position softened
last week after Prime Minister Haider Al-Abadi said his country would share the
burden of cutting production along with the rest of OPEC.
Clear Quotas
OPEC’s crude production was
33.64 million barrels a day in October, according to its independent estimates.
That means the group would need to cut by 640,000 to 1.1 million barrels a day
to comply with the Algiers target range.
Most analysts expect OPEC
to sign an accord to reduce output, but only seven out of 20 expect it to
specify how much each member should cut, complicating the task of investors
assessing the impact on markets.
An OPEC deal with clear
quotas would boost prices to $55 a barrel, said Pughof Capital Economics,
with investors switching their focus to the issue of compliance. He assigns
that outcome a 25 percent probability, while seeing a 15 percent chance of
there being no deal at all, a scenario that would trigger a crash in prices to
below $40.
OPEC’s
output cut on Dec. 17, 2008,following a slump in prices from a record
$147.27 a barrel five months earlier, didn’t initially convince the market.
Priceson the New York Mercantile Exchange dropped a further $9 over the
three days following the deal, before rebounding to almost $50 a barrel early
in 2009. Two months later, crude was still trading below pre-OPEC meeting
levels and only made a sustained break above $50 in May.
"The messaging is going to
be a huge challenge,” said Croft of RBC Capital Markets. "A statement that is
super short on details about the allocation of the cut could be dismissed as a
non-event despite key members -- such as the Saudis and the Gulf Countries --
being committed to making the math work.”
(Bloomberg, November 28, 2016
)