The Fuse

OPEC Uses Freeze Rumors to Manipulate Prices…Again

by Nick Cunningham | September 01, 2016

Before the oil price crash of 2014, OPEC was willing to take coordinated action to manipulate fundamentals, imposing limits and quotas on member countries to correct an oversupplied market or ramping up output when supply became tight.

However, in the recent price fall, OPEC has declined to cooperate on adjusting output levels. Whether the group’s strategy was the result of wanting to drive out high-cost producers, recognizing that production cuts could be counterproductive, or having to deal with competing interests within the group, the bottom line is that OPEC has not taken coordinated action for years.

OPEC has repeatedly used rumors of a coordinated production freeze to fuel a speculative fire that has driven up oil prices to the cartel’s benefit.

Yet that does not mean that OPEC lacks influence over oil prices, or that it has not been using its clout to great effect. Throughout this year, OPEC has repeatedly used rumors of a coordinated production freeze to fuel a speculative fire that has driven up oil prices to the cartel’s benefit.

OPEC is once again dangling the prospect of a production freeze deal at an upcoming meeting in September. There are good reasons to doubt the group’s ability or sincerity to reach a deal, but several key countries are expressing a new willingness to negotiate.

Talking up oil prices

In the first quarter, just as oil prices hit their lowest level in more than a decade, several OPEC producers, including Saudi Arabia, floated the idea of a potential output freeze, an idea that originally came from struggling member Venezuela. Sub-$30 oil was enough to focus some minds and prompt speculators to bet on higher prices, and even Russia suggested that it was open to some intervention. Oil prices rallied in February following the decision to host negotiations in Doha in April.

Of course, the Doha talks fell apart at the last minute, but OPEC had benefitted in the intervening weeks from the rally that it sparked just by talking up the market. Oil prices surged more than 60 percent between February and April, rising above $40 per barrel. The failed Doha talks led to a brief dip in oil prices but did not kill off the rally, and crude rose to $50 per barrel by June. While the talks were widely condemned as a failure in the media, they succeeded in raising prices.

But benchmark prices plunged once again in early August amid a persistent glut of both crude oil and refined products. WTI briefly dropped below $40 on August 2, down more than 20 percent from the June high.

Oil surged by more than 20 percent in just two weeks after OPEC said that it would meet on the sidelines of an energy conference in Algeria to discuss a possible cap on output.

Coincidentally, OPEC surprised traders once again with renewed talk of a production freeze just as oil entered bear market territory. Oil surged by more than 20 percent in just two weeks in mid-August after OPEC said that it would meet on the sidelines of an energy conference in Algeria at the end of September to discuss a possible cap on output.

doha

The move was particularly effective because OPEC’s timing was perfect. Oil speculators had shed long positions on oil contracts and built up a record number of short bets. The announcement that a production freeze was back on the table was enough to spark a rally as speculators closed out a massive pile of short positions. Speculators swung back in the other direction, going long, and taking crude prices with them back to the $50 level.

A third bite at the apple

After the August rally in prices, top OPEC members seemed to downplay the prospects of a deal, reiterating positions about protecting their rights to increase production. Saudi Arabia managed to ratchet up production to record levels over the summer, while both Iran and Iraq are eyeing higher output levels. It all was following the same script as before—play up the potential for a coordinated freeze but take unilateral action to boost output and benefit from higher oil prices in the meantime.

But the speculation-driven oil price rally quickly ran out of steam in late August, and oil prices plunged back to the mid-$40s per barrel. Here we are, once again, with oil prices falling due to concerns about oversupply. It should come as no surprise then that another round of chatter from OPEC has commenced. At the end of August and the beginning of September, several top officials from key OPEC countries marched out in front of the media to talk up the Algeria meeting.

On August 25, Iranian state news said that Iran’s oil minister Bijan Zanganeh would attend the meeting in September. Iran did not hint that it would agree to a freeze, but because Iran is close to hitting its pre-sanctions production levels—something that it has insisted is a prerequisite to any coordinated action—its attendance suggests a certain openness to negotiations. This week, Iraq’s Prime Minister Haider al-Abadi voiced his support for a production freeze deal. “We support freezing oil production by OPEC due to the sharp decline of oil prices,” al-Abadi said at a news conference. But that came just a week after al-Abadi said that Iraq was not interested in a deal until it boosted production further.

“If other producers were to agree, it is reasonable to accept Saudi Arabia to go along with it.”

Saudi Arabia also seems more enthusiastic about the Algeria meeting all of a sudden. “We don’t believe any significant intervention in the market is necessary,” Saudi Arabian Energy Minister Khalid Al-Falih told Reuters on August 25. But a week later, the government appeared more open to such an intervention. “I think there is a move toward a common position, toward a common effort,” Saudi Foreign Minister Adel al-Jubeir said in Tokyo on August 31. “If other producers were to agree, it is reasonable to accept Saudi Arabia to go along with it.” That came on the same day that WTI fell more than 2 percent to a three-week low at just under $44 per barrel. It could just be a coincidence, but a steady stream of positive comments about the potential for coordinated action are coming from OPEC members immediately after a fall in oil prices.

Is this time different?

It’s uncertain whether there will be an agreement in Algiers, but the market will be watching closely, and OPEC sources will likely try their hardest to talk up the price as much as possible in the meantime.

Despite statements given to the media, it is not clear that participating members actually want a deal or think that one is necessary. An OPEC official from an unnamed Gulf country told The Wall Street Journal that “[i]t is not really necessary to act now,” citing an oil market that is moving toward a physical balance between supply and demand. Another OPEC official from a Gulf country dismissed the notion that a freeze deal could even be reached in such a short period of time. “These things can take several meetings to be implemented,” the source told the WSJ.

The Doha talks collapsed in April because Saudi Arabia pulled out at the last minute amid Iran’s refusal to budge. Distrust and suspicion could once again keep a final accord out of reach. Moreover, recent history suggests that there is little reason to believe that members can overcome their mutual contempt.

This is the third time in 2016 that OPEC has tried to raise expectations of coordinated action by talking up the possibility of a deal. But smarting from OPEC’s antics over the past year and wary of another round of bluster, analysts have low expectations of the upcoming meeting in Algeria. In a note to clients, Morgan Stanley wrote in August that a deal was “highly unlikely.”

But this time could actually be different. If Saudi Arabia, Iran and Iraq are now open to a production freeze, there should be no reason that they cannot seal the deal. Saudi Arabia’s oil production hit a record high in July at 10.67 million barrels per day and Iran is only 80,000 barrels per day under its pre-sanctions output levels. Iran and Iraq will struggle to ramp up output any further, making a production freeze not a big sacrifice. Leaving aside the actual real-world effects on global oil supplies by freezing output at record levels, a deal, at least on paper, is possible.

Moreover, Reuters reports that Saudi Arabia is anxious for higher oil prices ahead of its planned partial-IPO of Saudi Aramco. “The Saudis have to play differently. They cannot sell 10 percent of Aramco if the price of oil is miserable,” an OPEC source from a non-Gulf country told Reuters. “The Saudis are going to Algeria for a freeze,” a source within OPEC told Reuters.

It’s uncertain whether there will be an agreement in Algiers, but the market will be watching closely, and OPEC sources will likely try their hardest to talk up the price as much as possible in the meantime.

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