The Fuse

Doha Failed, but Freeze Rhetoric Still a Success

by Leslie Hayward | April 18, 2016

The failure of the Doha talks to result in an official production freeze among 16 oil producing countries, including most members of OPEC plus Russia, has prompted endless speculation on the future of the oil market, and OPEC’s role within it. In some views, OPEC’s credibility is permanently damaged, and the outcome solidifies Saudi Arabia’s commitment to resigning its role as oil market manager, and diversifying its economy away from oil revenues in a much broader sense. Others make the case that the urgency for a formal deal had already been removed: Brent crude was above $40 per barrel, fundamentals were beginning to rebalance, and mere talk of the production freeze helped boost prices. Meanwhile, the news of a collapsed agreement has failed to result in a sustained market selloff, and prices have already recovered their overnight losses.

“Doha worked,” writes Bob McNally of The Rapidan Group in an email to The Fuse. “Traders were scared out of their short positions and crude rallied 40 percent since it was broached. But now, geopolitical tensions take precedence over managing oil market expectations. Barring another price collapse, producers will be guided by their own economic and geopolitical interests in the context of a free market for oil for the first time since the early 1930s.”

Who called it?

Ahead of the meeting, there was a difference of opinion between traders and analysts in the likely outcome. Many top market observers argued that, even considering the strife between Saudi Arabia and Iran, the downside risk to oil prices would be enough to prevent the eventual result: A total collapse of the freeze agreement, and greater damage to OPEC’s credibility.

Matthew M. Reed, Vice President of Foreign Reports, tells The Fuse, “There was always the risk of a failed meeting driving down prices. Assuming no meeting is better than a failed one, it’s quite incredible that it came to this. Many if not most of those attendees must have had high confidence in a deal. Otherwise, why show up?”

Many top market observers argued that, even considering the strife between Saudi Arabia and Iran, the downside risk to oil prices would be enough to prevent the collapse of talks.

Morgan Stanley placed odds on a collapse of talks at 15 percent, with 70 percent odds of an agreement being reached. Barclays said, “A vague agreement is likely, which would buy producers time to weather the next couple of months before peak summer driving season.” According to Reuters, in another view, the consultancy Petromatrix “saw the Saudis as a G20 member pushing for a deal to freeze output because both the IMF and the U.S. Federal Reserve are growing increasingly impatient about low oil prices.”

“There were plenty of big and small indicators pointing to a deal, with officials from several countries expressing confidence,” says Reed. “Besides that, in countries like Russia, we started to see more and more chatter about technical details. This wasn’t lazy jawboning. These were Russians talking to Russians about the mechanics of any deal; preparations were being made.”

In the final days before the meeting, many traders positioned for a selloff, buying a large amount of put options to protect against a move to the downside. The tension between Saudi Arabia and Iran, along with failed OPEC meetings in the past—such as the ones in December 2015 and November 2014—led others to short the market ahead of this past weekend, based on lack of trust that the participating member states could reconcile their differences.

Almost all market watchers were in agreement that even if a freeze deal was struck, the impact on physical fundamentals would be limited, and insufficient to rebalance fundamentals.

“If there is to be a production freeze, rather than a cut, the impact on physical oil supplies will be limited,” IEA said in its most recent monthly report. “With Saudi Arabia and Russia already producing at or near record rates and very little upside seen apart from Iran any deal struck will not materially impact the global supply-demand balance during the first half of 2016.”

$40 oil was enough

Even though the freeze attempted to include many non-OPEC members, the collapse of talks has resulted in renewed calls that OPEC’s relevance is a thing of the past. Clyde Russel in Reuters captures this view: “It was the worst possible outcome for oil producers at their weekend meeting in Doha, with their failure to reach even a weak agreement showing very publicly their divisions and inability to act in their own interests.”

Others argue that Saudi Arabia already got what it wanted out of the ongoing talks, and feared the upside implications of a formal freeze agreement more than the downside. “The two months of preparation for the Doha meeting contributed to a 35 percent run-up in crude prices and that’s probably about as much as Saudi Arabia was comfortable with,” writes Julian Lee in Bloomberg Gadfly. “The last thing the kingdom wanted was the oil price rising to a level that allows high-cost projects to move forward.”

And where exactly is that sweet spot, at which the industry can survive without unleashing a flood of new supply? According to Casey Sattler of Energy Intelligence, Brent at $40 per barrel is still painful for the industry, but $60 is high enough to bring a return to growth from U.S. shale—suggesting that perhaps $50 per barrel is the “Goldilocks” price point. At this level,“the oil industry could function healthily at for a sustained period of time within a ‘lower-for-longer’ environment.”

Concern for what will happen if prices rise and stay above $50 might have contributed to Saudi Arabia’s willingness to walk away from Doha.

Concern for what will happen if prices rise and stay above $50 might have contributed to Saudi Arabia’s willingness to walk away from Doha. “The Saudis have recognized they need more than oil and they need to open their economy,” one veteran trader tells The Fuse. “They want to get as much from their oil as they can now. Shale has really changed everything. They know we might not get back to the $100 we had before. Back when we had $100, there was China’s demand growth, geopolitical outages like Libya, and fund money betting on higher prices from quantitative easing. The stars may not align like that again—the energy game might really be changing. In OPEC, it all boils down to what the Saudis are thinking, and now it seems we know what they are thinking.”

Price collapse could renew talks

Oil prices dropped following the news out of Doha, but no massive selloff has materialized—Brent crude recovered its immediate losses and is back to near $43, where it closed on Friday. The lack of a market response is likely because there has been a gradual rebalancing of fundamentals concurrent with freeze discussions over the past few months, while a supply outage of over 1 mbd in Kuwait is helping to buoy prices.

“Barring oil price crashes that threaten financial contagion, producers are unable to muster even a pretense of coordinated action.”

According to Reed, high prices could reduce the likelihood of action at the upcoming OPEC meeting in Vienna on June 2. “It all depends on price. If prices fall into the gutter again then the conversation could pick up sooner than June 2, of course. Much depends on Iran’s production and exports. If those volumes are steady by June 2, then the OPEC meeting could be consequential, even if the organization’s credibility is hurting after this weekend.”

That said, prices are likely to need a truly dramatic leg down to renew interest in cooperation among oil producers. According to McNally, “The Doha failure means that barring oil price crashes that threaten financial contagion—the circumstances in January and February that triggered Gulf producer support for the gambit—producers are unable to muster even a pretense of coordinated action.”