Deal or No Deal, OPEC’s Freeze Talks Are Working

Bloomberg: Even as speculation builds over whether OPEC will clinch an output deal with Russia this month, their negotiations are already paying off.

Hedge funds and other investors reversed their bets on falling oil prices at the fastest pace in five months after producers said they would meet in Algiers, data from the U.S. Commodity Futures Trading Commission show. While skepticism has grown about whether the Organization of Petroleum Exporting Countries, whose representatives held a flurry of meetings from Moscow to Paris last week, can overcome internal conflicts, speculative short positions in U.S. crude are still 41 percent below their August peak.

Oil climbed as much as 16 percent in the weeks after OPEC announced talks in the Algerian capital, extending a rebound from a four-month low. While the desire of Iran and Iraq to boost output prompted doubts there will be a deal, crude has held much of the gain, just as prices retained their initial boost from the previous failed attempt to freeze production in Doha in April.

“The best they can do is alert short-sellers that, if they really are pushed, they can take a few barrels away,” Jan Stuart, global energy economist at Credit Suisse Securities LLC in New York, said by e-mail. “That changes the risk-reward calculation for investors, and the record short position of just a few weeks ago is unwound and becomes more neutral.”
Money managers slashed their short positions in West Texas Intermediate crude by 124,819 contracts, or 57 percent, in the three weeks to Aug. 30, the biggest percentage pullback for such a space of time since late March, according to data from the Commodity Futures Trading Commission. Bearish bets rebounded by 34,954 contracts the following week, as doubts about the seriousness of any OPEC-Russia pact grew.

WTI, the U.S. benchmark, was trading 0.5 percent higher at $45.11 a barrel at 11:02 a.m. in London. Brent was up 0.3 percent at $47.24 on the London-based ICE Futures Europe exchange.

Talks in Algiers on Sept. 27 will face the same political obstacles that thwarted the effort in Doha, which collapsed because of Saudi Arabia’s last-minute insistence that Iran needed to join in, according to Commerzbank AG. Iran, which rejected the Doha plan while it ramped up output following the end of sanctions, has said it still has reservations about participating.

Saudi Arabia may also be reluctant to constrain its production when this would only spur U.S. shale drillers to fill the gap, according to Credit Suisse’s Stuart. With supply management a “losing game,” verbal intervention may remain the most profitable option, he said.

Capping Production

Discussions have shifted away from freezing output at current rates to capping production at levels of each country’s choosing, a system which could see producers pledge millions of barrels of additional supply as they expand capacity or — in the case of Nigeria and Libya — restore disrupted exports.

With this in mind, prolonging the negotiations may be better than concluding an agreement that does nothing to reduce the global surplus, said Olivier Jakob, managing director of consulting firm Petromatrix GmbH in Zug, Switzerland.

“If a freeze is agreed but turns out to be tepid, then speculators will no longer be shy in placing their bets,” said Jakob. “The best oil bulls can expect is the implied promise of concrete action on production if prices slip into the low $40’s for a sustained period. OPEC is going to continue to rely on words and time for price support.”

Using Words

Still, the organization can only buttress the market with words for so long, according to Eugen Weinberg, head of commodities research at Commerzbank AG in Frankfurt. Prices held most of the 55 percent gain amassed in the three months before the Doha meeting, even though that ended with no agreement, thanks to supply disruptions in Kuwait, Canada and Nigeria. OPEC might not be so lucky this time.

“After the debacle of Doha, prices were able to stay high and even get higher,” said Weinberg. The risk for OPEC of another failure would be that “nobody really believes in them. They’re more like the boy who cried wolf,” he said.

The threat of action to curtail output is needed now more than ever to cushion prices as the outlook for supply and demand deteriorates. Both OPEC and the International Energy Agency revised their forecasts for 2017 this week, with the IEA now warning that the glut will persist through next year.

“What OPEC has done very well is it’s acted like any other central banker, and any time the market gets too far off-side, they’re quite adept at scaring those shorts away,” Adam Longson, commodity strategist at Morgan Stanley, said in a Bloomberg television interview. “It almost doesn’t matter fundamentally” whether there’s an agreement in Algiers, he said.