The Fuse

OPEC’s Rhetorical War Against Speculators Continues

by Matt Piotrowski | August 16, 2016

In a press release in March 2004, when oil markets were on the cusp of taking off and setting a string of record highs, OPEC said that “high oil price levels remain predominantly a consequence of … speculators in the futures markets,” along with other factors such as U.S. gasoline dynamics and geopolitical concerns. The cartel failed to mention its role in manipulating supply in the prior years to prevent inventories from building. In 2008, when the oil market hit its all-time high of $147 per barrel, then Saudi Oil Minister Ali al-Naimi told a U.S. ambassador that “speculators bore significant responsibility for the sharp increase in oil prices in the last few years.” Again, the comments were to deflect blame for any fallout from conditions that OPEC created, whether through instability in member countries, limited supply investment, or production curbs.

OPEC comments about speculators have been to deflect blame for any fallout from conditions that the cartel created, whether through instability in member countries, limited supply investment, or production curbs.

The finger-pointing continued this decade. In 2012, when prices consistently traded above $100, Naimi, speaking at the International Energy Forum, said that oil market speculation was based on the perception that supply would be constrained in the future and bluntly blamed non-commercial actors in the futures market for distorting prices and causing volatility.

Even when the market collapsed in 2014, which has brought about a continued low-price environment and has hurt producing countries, IOCs and independent companies, OPEC said financial players were the reason for the sharp downturn. “The kind of speculation oil markets have had to suffer in recent times…not only destabilizes trading patterns, but creates great uncertainty,” OPEC said in its Bulletin in September 2014. “This, in turn, makes it difficult to plan going forward.” In May of last year, OPEC reiterated this view, saying that supply-demand fundamentals didn’t warrant such a sharp price drop in 2014-15: “There was one other important factor that contributed to the downturn, especially as the price decline gained momentum. That was speculation.” Naimi, speaking at IHS CERAWeek in February before his retirement, quipped that speculators affect prices only in the short term, “but the short term is here to stay.”

When prices were high, OPEC members benefited from any speculative-driven rally. Now, however, the tables have turned—OPEC members, already suffering from low prices, are jittery that speculators will sell the market down again toward previous lows.

While financial actors—which include hedge funds and other investors—do indeed drive oil prices from time to time (a subject that naturally gets more attention when prices are high), OPEC used speculators as a convenient argument for high oil prices in attempts to take the spotlight off of its policies and instability in member countries that contribute to price volatility and distortions. When prices were high, OPEC members, of course, benefited from any speculative-driven rally. Now, however, the tables have turned—OPEC members, already suffering from low prices, are jittery that speculators will sell the market down again toward previous lows. Hence, the freeze rhetoric, which benefited the group earlier this year, is back. And it’s worked once again. NYMEX WTI and Brent have soared by more than 16 percent to $46 and $49, respectively, since early August, and last week speculative net length rebounded after falling sharply for about two months.

doha

The OPEC rhetorical war against speculators has heated up again, with recent cuts in net length and many financial players taking short positions—which are essentially bets on lower prices—driving the market below $40 in early August, down from above $50 in June. Saudi Energy Minister Khalid al-Falih, critical of speculative activity, said, “The large short positioning in the market has caused the oil price to undershoot. However, this is unsustainable.”

Freeze talk to weed out shorts

With net length in NYMEX crude futures and options having collapsed by some 70 percent over a two-month period and the price of WTI falling by almost 25 percent, talk about OPEC and some non-OPEC producers capping production through a freeze has conveniently resurfaced to change sentiment among speculators.

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The latest comments from OPEC members, along with some non-OPEC producers such as Russia, mirror talk from February through April earlier this year. Oil prices fell into the $20 range in mid-February as speculators cut net length and reached a record number of short bets, but producers were able to successfully talk the market up by announcing their intentions to freeze output. Even though negotiations fell through in April at the talks in Doha amid Iran’s refusal to go along, OPEC, during the two-month period, successfully jawboned the market 40 percent higher and forced speculators to abandon bets on lower prices. “We see this as more of a replay of the run-up to the April meeting in Doha that failed to produce an agreement,” said Citi Futures analyst Tim Evans in a note to clients. “Even a production freeze represents more of a status quo than a bullish shift. Market sentiment may be supported, but the physical balance in the market remains unchanged.”

During the current rebound, there’s been plenty of bearish news that’s been mostly ignored—the U.S. reported two contraseasonal crude stock builds, OPEC data show record output, Chinese buying has slowed down, and the rig count in the shale patch has risen, raising suspicions that the latest price increase is simply the result of OPEC talking up the market. Al-Falih, in his recent comments, didn’t mention these bearish trends, but instead said the “market rebalancing is already taking place.” Some analysts beg to differ.

Wanting it both ways

In 2006, former Fed Chairman Alan Greenspan told the Senate Committee on Foreign Relations that speculators hasten “the adjustment process” in the oil market. In other words, activity among investors accelerates price movements in both directions to help restore fundamental balance by stimulating supply and curbing demand, or vice versa. To be sure, speculators push the market around and at times detach prices from fundamentals. But for OPEC to time and again go to war against speculators is disingenuous and can send misleading signals, masking deeper structural problems in the market.

OPEC, chiefly its leader Saudi Arabia, wants to have it both ways. The current Saudi strategy is poised to choke off non-OPEC supply investment, which requires a weak market, but OPEC also wants prices to be higher than current levels in order increase members’ revenues.

OPEC, chiefly its leader Saudi Arabia, wants to have it both ways. The current Saudi strategy is poised to choke off non-OPEC supply investment, which requires a weak market, but OPEC also wants prices to be higher than current levels in order increase members’ revenues. Taking action to freeze or cut production appears too risky given that the group has trust issues since members have historically cheated on production targets. Moreover, if prices rise too sharply, U.S. shale producers would be given another lifeline and essentially flood the market. So OPEC is left with keeping output levels high while trying to talk up the market as much as it can in order to buy time for the long-awaited rebalancing and inventory draw down.

 

 

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