Did OPEC just engineer the short squeeze of a lifetime?
I have to admit that this one, this deal, is about as unexpected as you could ever get.
Think of the arc of it. Last week, OPEC ministers leaked that there was no deal. Nobody would agree to cut back and the best you might get was a freeze at really high levels, if that.
That caused oil to take its usual dive to the low $40s and lots of chatter that if there is no deal, then the $30s beckoned.
Of course, that caused the usual gang of whipsawed commodity traders to go heavily short, betting that any "deal" was no deal at all and oil would fall because there is, as we all know, a real glut.
Even as early as this week, we heard there were implacable forces at work: The Iranians wouldn't agree with the Saudis who wouldn't agree with the Iraqis, who wouldn't agree with the Indonesians who actually may have suspended their OPEC membership entirely because of the agreement.
But this morning we learned that the Saudis are willing to cut a million barrels of production a day and that plus a couple of hundred thousand barrels cut from other countries -- no clarity on that -- was enough to bring everyone to the table.
Now, just so we understand, there really isn't anything in this deal that seems to curtail anything that Iran and Iraq are doing right now. That should mean that the 1.2 million barrels could be chimerical.
But that's not the real issue. The real issue is that the Saudis control OPEC because they have the ability -- unlike all the others -- to just raise or lower their output freely.
The Saudis, going into the meeting, had upped their production to about 11 million barrels a day from 10 million, so they are simply going back to where they were last year.
However, you can do the math. If the Saudis can boost the price of oil by 10% by taking a 10% cut in production, they will do fine. Selling 10 million barrels a day at $50 is pretty much a push vs. selling 11 million barrels at $45, and it's much better than selling 11 million at $40, where oil might have been headed.
It's pretty much a no-brainer because if the other OPEC countries can't physically pump more than they are, than the algebra works and oil stays higher for now.
But there's another aspect that OPEC can't count on: us, as in the United States. The Saudis have created an umbrella under which the U.S. producers, with below-$50 crude, can really turn on their spigots and take up the slack. Not to the point, necessarily, of driving oil back, especially if there is worldwide growth, but certainly to the point where the production estimates -- what the analysts follow -- are too low.
That's why you are seeing these massive moves in the likes of the domestics with good Permian exposure, which can make money at half this price, or the Oklahoma area known as SCOOP, which is, in some parts, equally as valuable.
And that's why you could get such exaggerated moves in an EOG (EOG) or a Pioneer (PXD) or a Cimarex (XEC) . They've made huge investments and acquisitions in the best parts of Texas during the chasm and they are now prepared to reap the harvest of the Saudi umbrella.
Now why were the traders so wrong? Why were they so short? I think the answer is simple: because there was enough chatter about the failure of a deal coming from all directions that the risk/reward on the short side just seemed like such a better bet.
The smart money got played and they got it wrong. The true believers? They got it right.