How to play the OPEC deal and beat the oil investor herd
The latest OPEC report was bullish, not bearish. Still, a deal needs to get done.
Before anything else, recognize that investors in the oil space stare at their feet and rarely look ahead far enough to identify anything other than fast-money trades. That is not a criticism; it is an observation, and one we can use to take advantage of situations from time to time.
The herd-like mentality that often governs the decision of oil traders can cause overshoots and undershoots to oil prices CLZ6, -0.85% from time to time. Also, media headlines can play a significant role in the decision-making process of these fast money traders, but it is all due to this very real fact: Oil traders are buying and selling based on price trade futures contracts that have expiration dates.
The reason oil investors react so quickly to headlines and often join in momentum moves is that their investment has an end date, and making fast decisions bodes well for them. But that also creates opportunity for people who are paying attention.
The headlines recently suggest that OPEC will not be able to reach a deal when they meet on Nov. 30. Those headlines have driven oil prices lower, momentum has been down, but the headlines are not the whole story, and undershoots are arguably taking place.
The headlines have it wrong.
OPEC is going to reach a deal to cap and cut production when it meets, and the deal is going to be significant enough to cause demand to exceed supply by 800,000 barrels per day on average in calendar year 2017. Where currently we have more supply than demand, in 2017 there is going to be more demand than supply for oil, and oil prices are going to go through the roof.
Iran is going to cap production near 4 million barrels a day, a level at which they are producing today, suggesting no additional production from Iran, Saudi Arabia is going to be OK with that, and aside from a few special circumstances other OPEC members are going to participate. That participation will bring Russia into the game, and Russia will participate, and a material production cut is coming. Smaller producers like Oman and other non-OPEC producers have also already vocalized participation, but the wild card has been Iran.
Iran has what they want, and an OPEC deal is imminent.
In addition, Saudi Arabia has a vested interest that extends beyond the health of their economy to see oil prices surge over the next year or so, so they will not stop supporting prices. Saudi Arabia is going to issue an IPO for its oil assets, and it wants to get the best price possible, and the only way to do that is to get oil prices higher before the IPO comes to market.
That additional vested interest is exactly why Saudi Arabia has changed its tune from what it was eight months ago; that is why Saudi Arabia is accepting the request to get back to pre-sanction levels by Iran, and ultimately that additional vested interest is exactly why the deal is going to get done.
Obviously, conditional details exist here, but the point is very clear: Everyone wants a deal to get done, including Iran, who contacted Venezuela directly soliciting participation from them, and together production cuts can take place globally that cause demand to far exceed supply in the second half of 2017, which ultimately would equate to roughly 800,000 barrels a day for the calendar year.
Not only is a deal going to get done, but that deal is going to be big and prices are going to surge. Oil traders who are looking at the headlines did not get through the recent OPEC report close enough to identify the opportunity. Instead, they just read the headlines that suggest a deal looks unlikely, but those headlines don’t tell the entire story, and this space traditionally overshoots and undershoots in a bandwagon fashion, and we’re near a relative trough.