Oil Falls, OPEC Reacts. Where To From Here for Oil?

Oil
Is the sun setting on OPEC?

Oil made headlines this week as price tumbled back down to levels last seen in November 2016, pre-OPEC production cut. With the US increasing production and  inventory numbers stubbornly strong traders & investors must ask: can OPEC still set the price of oil? 

A complex web of supply and demand.

For the uninitiated, oil is a complex and difficult market to trade. Price is influenced by countless factors including:

  • geopolitical tensions
  • supply & demand
  • storage concerns
  • complex hedging
  • market structure issues
  • and wide range of market participants 

On the supply side, the largest and most influential participant is OPEC. Since the oil shock of 1973, when OPEC speaks the world listens. In November ’16, OPEC pledged to cut production to combat slumping prices. The cut spurred a rally that defied troublesome supply-side fundamentals including an increasing US rig count and steady storage builds (or lack of drawdowns).

To the authors surprise, OPEC members stuck to their pledge and achieved record compliance. This suggests that members still find value in the system, and are loyal to it. Previous doubts about the commitment of OPEC members have been put to bed, for the time being.

Unfortunately for oil investors, record compliance had little impact on inventories, leading to this weeks sharp decline.

Where to from here for OPEC and Oil?

In response to Thursday’s price capitulation, Saudi Arabia reassured the market that Russia is ready to join OPEC. OPEC’s next meeting is scheduled for May 25, where they are widely tipped to extend production cuts for another 6 months. Friday’s price action suggests that oil has found short-term support here. For those who are looking at longs in energy companies, ETF’s or derivatives, consider the following questions before making your trades:

  • Has a production extension been priced into the market?
  • Does OPEC need to do more than extend current cuts to impact inventory numbers? If so, by how much? Are member states willing?
  • At what price does it become unviable for US producers to add more rigs?

Of course, these are just some of the many questions you need to ask yourself when making a trading or investing decision, especially in the complex world of energy markets.