Last week, the press was treated to disappointed commentary from OPEC's key member Saudi Arabia towards the U.S., saying they were "duped" and "forced" to raise production ahead of potential Iran sanctions going into full effect.
The price of oil fell 18% in October, including a one-day drop of 7% -- down to $65/bbl. Iran sanction waivers were given to most key trading partners, but that was known over the last month as most trading partners had already rejected Trump's demands to stop importing Iranian oil. They were doing it regardless, waivers just sealed the deal.
Of course, when one notices such violent price gyrations, it is easy to find any number of sensationalist and propagandist stories to match the move. Typical. No one bothers to look at how the fundamentals have changed, but prefer to use conspiracy theories to appease their left hemisphere.
Given the heated tweets and public disapproval between U.S. and Saudi oil policy, there have been whispers that Saudi could or would leave the OPEC. Let's put some history into context here before we jump to conclusions. There is an extremely strong link between oil, OPEC, and petrodollars; oil priced in dollars. It dates back to the Bretton Woods system going back to the 1970s, and any change to this thesis could have severe ramifications beyond just the oil market.
It's a beautifully engineered cycle, whereby oil bought from the Saudis gets pumped back into the U.S. via purchase of U.S. Treasury bonds and so on. To say OPEC may be dissolved, or Saudi leave, is making a huge statement, which would be politically contentious on a lot of counts.
Taking a step back from political theories, which are way above my pay grade, what I can do is theorize on the fundamentals of the physical oil market and its inventories.
Netflix soap opera weekly episodes aside, Saudi Arabia and Russia pumped more oil, as seasonally it was required for them to do so. We were in the peak gasoline summer driving season and refineries were pumping crude at maximum levels to monetize on the very lucrative crack spreads ($/bbl refining margin to process product out of crude).
Prices were nudging towards $85/bbl -- and predicted to be higher. The smart thing to do was to pump at highs so they could then take their foot off the pedal during the weak shoulder period, which is now.
All this was happening as emerging markets were blowing up -- as dollar interest rate rises were pushing their debt service costs higher and crumbling economies with current account deficits. Throw in U.S./China trade war and halt in global supply chain -- how could oil go unscathed when we were in midst of pricing in global economic slowdown? Perception differs from reality. Just look at the copper market: Sentiment, not reality, is everything. Hence the two-way battle in price.
For some time, OPEC, or rather the oil market, has really just been managed by three countries: the U.S., Saudi Arabia and Russia. Hence the new "unofficial" name: SauRuUS. It does not have quite the same ring to it as OPEC, but its relevance is quite significant. These three members produce more oil than the 15 members of OPEC altogether.
U.S. Shale has been growing significantly, given the high drilling rates and efficient hedging programs in place. It is up 2 million barrels per day year-over-year! Saudi Arabia and Russia decided to cut output in June to avoid an overbuild of inventories, as both countries would like prices above $50/bbl, but below $80-85/bbl, to promote a "healthy" price and demand environment, where everyone still makes money and customers are not choked with high prices that can cause demand destruction. According to IMF, they claim the kingdom needs about $73.3/bbl to balance their budget.
OPEC's next meeting will be hosted in Vienna on December 6. Russia and Saudi seem well aligned and have had each other's backs since 2016. U.S. shale still remains a mystery to the group, especially its production this past month. There is talk of a 500,000-1,000,000 barrels per day cut going into this December meeting. It seems rather pre-emptive and precarious debating a cut in December before winter heating season starts. Look at natural gas, we don't want that to happen to the oil market.
There are many moving parts, as we need to see how demand develops in the fourth quarter going into Q1 of next year. That is the hard part, as the market always extrapolates the past, never predicts the future. Then we have the infamous U.S./China Trade War games. Unless oil price falls below $60/bbl Brent, it would seem rather premature to cut now. But then again, plus or minus 500,000 barrels is entirely doable, as that was the increase in October, so we would only be cutting off from a high level.
Stay tuned. More fun and games ahead.