- A delay for the meeting.
- A continuation of output cuts is a given.
- The Saudis and Iran.
- Russia calls the shots.
- It’s all about war and trade - volatility to continue.
As the international oil cartel prepares to meet, the group that decides production policy for some of the world’s leading petroleum producers have lost most of its influence in the market. While the market still watches OPEC, two of the three leading producers are not members. The triad that dominates output is the United States, Russia, and Saudi Arabia.
The Saudis have always sat at the head of the table at the meetings of the oil cartel, even if their minister is not leading the meeting. However, since 2016, it has been the Russians that have the most influence. While remaining a non-member, Russia has played an integral role in the final decision on quotas. When it comes to the United States, daily production has grown to between 12.1 and 12.4 million barrels each day over the recent weeks. The US is now the leading producer of the energy commodity. The US has a long history of animosity with the cartel, which it views as a violator of anti-trust laws.
The issue facing OPEC at the upcoming meeting is if they will keep the 1.2 million barrel per day cut in place or change the quota based on recent market developments. Since April, the price of oil dropped, but it has come back over the recent trading sessions and now stands at close to the midpoint of the trading range between $50.60 and $66.60 on WTI and $59.45 and $75.59 on Brent crude oil futures. Most of the members of the cartel use the Brent price as a benchmark for their production. The membership must balance lower demand from China because of the ongoing trade dispute with the US, and an increase in tensions between the US and Iran. While the Iranians are cartel members, they continue to be at war with Saudi Arabia, which complicates OPEC’s decision-making process and has provided Russia with increased influence.
The United States Bent Crude Oil Fund, LP (BNO) is a product that tracks the price action in the Brent crude oil futures market.
A delay for the meeting
The biannual OPEC meeting was originally to take place on June 25-26 in Vienna, Austria. However, the cartel members agreed to delay the meeting until July 1-2. China is the world’s most populous nation, and the leading commodities consumer in the world, and energy and crude oil are no exception when it comes to the Asian nation’s consumption of raw materials.
In May, the trade dispute between the US and China escalated after President Trump became frustrated with the progress of the talks and Chinese backtracking on many of the critical issues for a deal. On May 10, the US slapped China with additional protectionist measures, and China retaliated on May 13. Earlier this year, markets had been optimistic that the two sides would reach a deal, but the optimism turned to pessimism in mid-May, and many commodities prices declined as the trade issues have weighed heavily on the Chinese economy. The price of crude oil suffered a significant decline in late May following the escalation.
The next significant event when it comes to trade is this week’s meeting between Presidents Trump and Xi that will take place on June 28-29. Initially, the OPEC meeting was to take place before the trade summit, but since the demand for crude oil from China depends on the future of trade, the ministers likely moved their meeting to July 1-2 so that they could factor in trade to their decision-making process.
A continuation of output cuts is a given
The price of nearby WTI futures was trading on June 26 at $59.50 per barrel with Brent futures at $66.50. Recently, Saudi oil minister Falih said that his nation and OPEC are “comfortable” with $60 to $70 per barrel crude oil. Brent is the benchmark pricing mechanism for the members of the cartel, and since the price of oil is in the middle of the comfort zone, it is unlikely that the oil ministers will alter the current production levels so long as there are no significant changes from the trade meeting in Japan this week. Therefore, we should expect that the 1.2 million barrel per day production cut from the late 2018 meeting will remain in place throughout the rest of 2019.
However, the path of least resistance for the price of crude oil is far from under the control of OPEC these days. The US’s profile as a producer continues to rise, and the cartel can no longer hold the US hostage when it comes to its energy requirements. As we head into the second half of 2019, bullish and bearish factors continue to pull the price of oil in opposite directions. OPEC is becoming little more than a bystander these days when it comes to the path of least resistance of the price of the energy commodity.
The Saudis and Iran
The current tensions in the Middle East between the US and Iran have escalated. Attacks on oil tankers, the downing of the US drone near the Strait of Hormuz by Iran, and more sanctions from the US on the theocracy in Tehran have been dangerous steps that could lead to hostilities on a grander scale over the coming weeks and months. US President Donald Trump used restraint when he declined to pursue a military response to the downing of the US drone stating that since no lives were lost, any military action that caused the loss of life would not be “proportionate.” However, the trajectory of incidents and more economic sanctions are making the leadership of the Iranian regime desperate. The odds of more events that lead to hostilities in the region are rising. Iran had promised that if they cannot ship their petroleum to customers around the globe, they would take steps to prevent other exporters in the Middle East from sending their crude oil abroad.
Meanwhile, the Iranians and the Saudis continue to battle in the region with a proxy war in Yemen and a blockade of Qatar. Iranian missiles have been finding their way into Saudi sovereign territory for months. The Saudi Royal Family under King Salman and Crown Prince Mohammed bin Salman want to see the theocracy disappear as they pose a threat to the current Saudi leadership. Iran hopes to spread its influence throughout the Middle East and would like nothing more than to depose the leadership of Saudi Arabia. There are no easy solutions for the region which remains on the brink of war. At the same time, Russia’s close alliance with Iran and a warming of Chinese-Russian relations pose the threat that a conflict in the Middle East could spiral out of control.
The relations between Saudi Arabia and Iran complicate the OPEC cartel and continue to undermine its future.
Russia calls the shots
When crude oil fell to a low at $26.05 per barrel in February 2016 on the nearby NYMEX WTI futures contract, and Brent fell to a bottom at just over $27 per barrel, Russia led a move to cut production in coordination with OPEC. The Russians bought lots of brownie points with the cartel members as the output declines worked and the price of crude oil recovered. Since then, the Russians have had an ever-increasing influence when it comes to the cartel’s production policies.
At the most recent meeting last November, the members of OPEC could not agree on a production cut as some members favored 1.5 million and others argued for a 1.0 million barrel per day decline in quotas. It was not until the second day that included the Russians in discussions, that Russian oil minister Alexander Novak, back from consulting with Vladimir Putin, got the cartel to settle on 1.2 million barrels per day. Russia agreed to participate in the production quota, which was a sign of their significant and dominant role within OPEC. The cartel will likely decide its quotas for the second half of 2019 on July 2, the second day of the meeting where the Russians are at the table.
It’s all about war and trade - volatility to continue
The path of least resistance for the price of crude oil over the coming days, weeks, and months will have little to do with the international oil cartel which has lost its influence in the market now that Russia calls the shots and the US is the world’s leading producer. The trade issue between the US and China will determine if demand is going to rise or fall with the Chinese economy. When it comes to the supply side, the potentially explosive situation between the US and Iran and the Saudis and Iranians will determine if the energy commodity continues to flow through the Strait of Hormuz for delivery to customers around the globe. Around 20% of the world’s crude oil supplies move through the Strait each day and any disruptions or hostilities that impact production, refining, or logistical routes in the Middle East could lead to price spikes to the upside regardless of Chinese demand for the energy commodity. The current situation on both the supply and demand side of the fundamental equation for crude oil is a potent cocktail for increased volatility in the crude oil market.
Since Brent crude is the pricing benchmark for Middle Eastern crude oil, the Brent futures market will likely see the highest degree of volatility when it comes to the actions of Iran and responses from the US and Saudi Arabia. The fund summary for the United States Brent Crude Oil Fund, LP (NYSEARCA:BNO), states:
The investment seeks the daily changes in percentage terms of its shares’ per share net asset value (‘NAV’) to reflect the daily changes in percentage terms of the spot price of Brent crude oil. The Benchmark Futures Contract is the futures contract on Brent crude oil as traded on the Ice Futures Europe Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire.
The most recent holdings of BNO include:
Source: Yahoo Finance
Since BNO holds Brent futures, it does an excellent job of replicating the price action in the benchmark crude oil. Brent futures rose from a low at $59.45 on June 5 to a high at $66.86 on June 26, an increase of 12.5%.
Over the same period, BNO moved from $17.30 to $19.50 per share or 12.7%.
The OPEC meeting on July 1-2 will likely be another example of Russia’s increasing influence when it comes to the decision-making process of the cartel. Trade and Iran are the factors that will move the price of crude oil between early July and the next time the cartel meets in late November or early December of this year. Fasten your seat belts as we could be in for a wild ride in the crude oil market over the coming months. I continue to believe that any price spikes will be on the upside, while economic factors continue to weigh on the price of the energy commodity. I am a buyer of crude oil on price dips and will likely buy call options to limit the risk to the premium for the option.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
seekingalpha.com · by Andrew Hecht · June 27, 2019