opec’s strategy boosts industry sentiment
Last Updated : GMT 06:49:16
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Last Updated : GMT 06:49:16
Arab Today, arab today

OPEC’s strategy boosts industry sentiment

Arab Today, arab today

Arab Today, arab today OPEC’s strategy boosts industry sentiment

non-compliance by OPEC members or Russia
London - Arab Today

Saudi Arabia has transformed sentiment in the oil market by assembling an unprecedented coalition of oil producing countries to agree output cuts in 2017.
Saudi officials have obtained pledges from OPEC members to cut production by almost 1.2 million barrels per day and from non-OPEC members by an extra 560,000 bpd during the first half of 2017.
In the process, Saudi negotiators wrong-footed many hedge fund managers, who had established large short positions in futures and options last month expecting there would be no deal or only a very weak one.
Hedge fund managers increased their short positions in the three main crude futures and options contracts by more than 200 million barrels between Oct. 18 and Nov. 22 amid skepticism about any deal.
But as negotiators narrowed their differences and then announced a deal among OPEC members nearly all those positions were closed: shorts were reduced by 174 million barrels in just two weeks between Nov. 22 and Dec. 6.
Saudi Arabia thus executed a successful short squeeze (whether that was the intention or not) and forced crude prices higher as bearish fund managers were forced to buy back their loss-making short positions.
Hedge funds in turn fueled the rally by opening an extra 154 million barrels of crude long positions over the last four weeks, including 94 million barrels opened the week after the OPEC deal was announced.
The hedge fund community has therefore pivoted from a relatively bearish position on Nov. 15 (when funds held a net long position of just 422 million barrels) to a bullish one on Dec. 6 (with a record net long position of 895 million barrels).
Brent prices have been jolted up from less than $45 per barrel in mid-November to over $55 in recent trading.
And Brent time spreads, seen as an indication of the expected supply-demand balance, have strengthened, though most of the tightening has come after the first half of 2017.
SUCCESSFUL DEAL
The abrupt shift in sentiment has led many analysts to conclude OPEC has returned to its former role as an active market manager after a number of years as a passive onlooker.
OPEC’s return may be overstated. As in the past, the key role has been played by Saudi Arabia, in conjunction with its close allies, with Riyadh calling on other producers to lend symbolic support.
Nonetheless, Saudi Arabia has succeeded in banishing the bearishness that haunted the oil market over the last six months and converting most hedge fund managers into oil bulls.
The resulting increase in prices will make all OPEC and non-OPEC producers better off and helps vindicate the deal.
Oil exporters are less likely to cheat if the deal delivers the promised significant improvement in revenues, at least at first.
All the components for a successful deal to restrict oil output, cut excessive stockpiles, and drive crude prices higher have fallen into place.
Market conditions and price movements resemble those during previous successful deals in 1999/2000 and 2008/09.
The International Energy Agency assesses the OPEC and non-OPEC agreements could move the crude market into a deficit of 0.6 million bpd during the first half of 2017, if they are implemented fully.
Full compliance is unlikely. Energy professionals expect OPEC countries to achieve only around half of the promised cuts. But the assessment gives some indication of how much non-compliance could be tolerated before the deal unravels.
The challenge now is to keep the hedge fund managers on side to avert a sell off that could push prices lower again.
Many funds appear to follow momentum-based strategies (buying when prices are rising and selling when they are falling).
So the very large concentration of hedge fund long positions has created significant downside price risk if prices stop rising and start to pull back.
To keep the funds bullish, Saudi Arabia needs to turn the OPEC and non-OPEC agreements into a evidence of a real reduction in crude supplies and a drawdown in stocks.
Saudi Arabia and a number of other exporting countries have already begun to notify refiners shipments will be cut in January, with news leaked to the media.
Since stockpiles are most transparent and reported with the highest frequency in the US, it would make sense to engineer a reduction in shipments to the US and try to cut stocks on US territory.
Nothing succeeds like success. Saudi Arabia needs clear evidence the deal is working to keep the hedge funds long and prices high, which in turn will encourage compliance with the deal, at least in the early stages.
The biggest risks come from non-compliance by OPEC members or Russia; a sharp rise in shale output; rising production from uncapped producers Libya and Nigeria; a drop in oil demand; or a fall in crude prices themselves.
If oil prices start falling, many hedge funds with long positions may be tempted to reduce them and take some profits.
The risks from all these sources are considerable and are likely to increase over time; any one of them could cause the OPEC and non-OPEC agreement to unravel if the gains from cooperation start to fade.
For now, however, Saudi Arabia has intervened successfully to shift sentiment and been rewarded with a price improvement of more than 20 percent.

Source: Arab News

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